Financing of Firms, Labor Reallocation and the Distributional Role of Monetary Policy

Abstract

We analyze monetary policy in a heterogeneous firm environment where cash-constrained firms finance operations through external financing and cash-unconstrained firms operate using internal funds. We show that firms respond differently to shocks: expansionary monetary policy sharply increases the relative employment of the constrained firms while positive productivity shocks induce a rise in the relative employment of the unconstrained firms. Our analysis points to a clear role of monetary policy in reallocating resources across sectors that differ in their financing capabilities. Furthermore, the predictions of our model match the empirical evidence in that financially constrained firms react sharply to monetary policy shocks but are less cyclical than un- constrained firms following productivity shocks. We also show that if the constrained firms are less productive than the unconstrained ones, then a monetary policy expansion tilts resources towards the less productive firms, which renders monetary policy less effective in stimulating aggregate economic activity.

Keywords: Heterogeneous Firms; Monetary Policy; Labor Reallocation; Firms’ financing

JEL Classification: E32, E44, E52