The effectiveness and risks of expansive monetary policy under financialization

Abstract

This paper incorporates low interest rates into a framework of post Keynesian theory of the firm under financialization and uses Compustat data to provide an empirical analysis of firm behavior in the eurozone for the period 2000–2018. It reasons that expansive monetary policy targeting low interest rates will only be effective in promoting investment in a scenario where shareholder value orientation (SVO) tightens the finance constraint on growth-maximizing managers. In contrast, when shareholder value maximization becomes the goal of the firm, expansive monetary policy may not only be ineffective in promoting growth but might actually be dangerous because it fosters financial fragility and promotes SVO. Data suggest that financialization in the eurozone represents a shift in the objectives of the firm toward maximizing free cash flows. However, there is no evidence that expansive monetary policy fostered leverage and an equity reduction in the eurozone. Still, the analysis shows that low interest rates were largely ineffective in fostering investment during the period 2008–2018. Therefore, monetary policy seems insufficient to promote investment and growth. Both expansionary fiscal policy and legal reforms that control shareholder power are needed.