Risk-Taking, Capital Allocation and Monetary Policy

78 Pages Posted: 14 Jan 2021 Last revised: 27 Apr 2022

See all articles by Joel Michael David

Joel Michael David

Federal Reserve Bank of Chicago

David Zeke

University of Southern California - Department of Economics

Date Written: February 22, 2022

Abstract

We study the implications of firm heterogeneity for business cycle dynamics and monetary policy. Firms differ in their exposure to aggregate risk, which leads to dispersion in costs of capital that influence micro-level resource allocations. The heterogeneous firm economy can be recast as a representative firm New Keynesian model, but where total factor productivity (TFP) endogenously depends on the micro-allocation. The monetary policy regime determines the nature of aggregate risk and hence shapes the allocation and long-run level/dynamics of TFP. Welfare losses from policies ignoring heterogeneity can be substantial, which stem largely from a less productive allocation of resources.

Keywords: monetary policy, heterogeneous firms, misallocation, productivity

JEL Classification: D24, E23, E32, E44, E52, E62

Suggested Citation

David, Joel Michael and Zeke, David, Risk-Taking, Capital Allocation and Monetary Policy (February 22, 2022). FRB of Chicago Working Paper No. 2021-01, Available at SSRN: https://ssrn.com/abstract=3765692 or http://dx.doi.org/10.2139/ssrn.3765692

Joel Michael David (Contact Author)

Federal Reserve Bank of Chicago

230 South LaSalle Street
Chicago, IL 60604
United States

David Zeke

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States

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