What Does Financial Heterogeneity Say About the Transmission of Monetary Policy?

Abstract

Do financial constraints determine the transmission of monetary policy? I examine this question using the staggered enactment of anti-recharacterization legislation as a source of exogenous variation in creditor rights that loosens firm financial constraints. Treatment effect estimates indicate constraints matter. A 25 basis-point expansionary monetary policy shock results in a 2 percentage-point higher investment growth among treated (unconstrained) firms, reflecting their flatter marginal cost curves for financing which amplifies responses to shifts in the marginal benefit curve. This relationship reverses during economic downturns when investment opportunities are scarce. I rationalize these findings in a static model with convex financing costs.

Keywords: Creditor Rights, Monetary Policy, Financial Frictions, Investment

JEL Classification: D22, K20, E22, E43, E52, G31