Firms’ Cash Holdings and Monetary Policy Transmission
Abstract: Liquidity, particularly cash holdings, may serve as an important cushion for firms to absorb macroeconomic shocks such as interest rate increases so that these shocks have only minimal effects on their operations, at least in the short term. For example, to finance their investments, firms with high levels of cash may not have to tap so deep into debt financing, the cost of which relates closely to interest rates. Understanding the role of corporate cash holdings is therefore paramount to formulating appropriate monetary policy in the current environment. This brief informs the ongoing policy debate by examining the effect of US nonfinancial corporate cash holdings on the transmission of monetary policy, both historically and in the present tightening cycle. This brief shows that in the current hiking cycle, firms have used the cash they accumulated in 2020 and 2021 to finance operations, growth, and payouts. Due to this depletion of the accumulated-cash buffer, the effects of interest rate increases to date on corporate investment will likely gain traction in the coming quarters.
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Provider: Federal Reserve Bank of Boston
Part of Series: Current Policy Perspectives
Publication Date: 2023-10-12