Firm Financial Conditions and the Transmission of Monetary Policy

Ferreira, Thiago Revil T.; Ostry, Daniel; Rogers, John

doi:10.17016/FEDS.2023.037

Working Paper

Firm Financial Conditions and the Transmission of Monetary Policy

Abstract: We study how the transmission of monetary policy to firms' investment and credit spreads depends on their financial conditions, finding a major role for their excess bond premia (EBPs), the component of credit spreads in excess of default risk. While monetary policy easing shocks compress credit spreads more for firms with higher ex-ante EBPs, it is lower-EBP firms that invest more. We rationalize these findings using a model with financial frictions in which lower-EBP firms have flatter marginal product of capital curves. We also show empirically that the cross-sectional distribution of firm EBPs determines the aggregate effectiveness of monetary policy.

Keywords: monetary policy; investment; credit spreads; excess bond premium; firm heterogeneity;

JEL Classification: E22; E44; E50;

https://doi.org/10.17016/FEDS.2023.037