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

Abstract

Using staggered enactment of anti-recharacterization legislation across US states as a source of exogenous variation in creditor rights, I find that a 25 bps expansionary monetary policy shock results in a 2 pp higher investment growth among treated firms relative to control firms after the enactment of the law. The anti-recharacterization laws improved the debt capacity of treated firms by strengthening creditor rights making them less financially constrained. Hence, my results show that financially unconstrained firms are more responsive to monetary shocks because they face a flatter marginal cost curve for financing investment, amplifying their response to movements in marginal benefit curve. However, the relationship reverses during low-interest rate regimes when investment opportunities are scarce.

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

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