What Kind of Firm is More Responsive to the Unconventional Monetary Policy? A Theoretical Approach

Abstract

The Unconventional Monetary Policy (UMP) of purchasing corporate bonds by the Federal Reserve has been one of the main policy responses to the COVID-19 crisis. An important question for policy design is whether this policy has been effective in boosting the firm's production and investment. While answering this question is challenging from a theoretical and empirical perspective, I provide a step forward in understanding the possible effects of this policy on firms' decisions using a theoretical and analytical model. The model suggests that the firm's default probability plays a key role in transmitting the effects of COVID-19 shock and the UMP. Using the model to evaluate two kinds of heterogeneities (size and initial credit risk), I show that large firms and high-risk firms are more affected by COVID-19 shock and are more responsive to the UMP. I then use a cross-sectional regression to evaluate the model’s prediction on the heterogeneity effects of UMP across firm size and to study the role of firms' characteristics in the effects of UMP. The estimation results support the size-firm hypothesis and suggest that firm's characteristics such as assets and operating income are relevant to understand the effects of the UMP.

Keywords: Unconventional Monetary Policy, COVID-19, Investment, Heterogeneity

JEL Classification: G28, G31, E52