Firm investment and monetary policy transmission in the euro area

Abstract

Introduction Monetary policy is generally thought to be able to affect business investment through multiple channels. First, a traditional ‘interest rate channel’ is identified, whereby changes in market interest rates imply changes in the cost of capital, which in turn affect investment. However, the difficulties of using aggregate data to find clear evidence of this channel are well known. Second, changes in market interest rates affect the net cash flow (i.e. cash flow after interest payments) available to a firm. Given imperfect capital markets, the availability of net cash flow will have an effect on investment. This is generally referred to as the ‘broad credit channel’. This chapter provides an investigation of those two channels based on results from a unique comparative study of the four largest euro area countries. Using rich firm databases for each country, standardised regressions were run to make comparison across countries feasible. Although, for confidentiality reasons, individual data could not be pooled – making formal statistical testing impossible – the standardisation of the analysis should still allow asymmetries in the working of these channels to be detected. In particular, reliance on firm data should make it possible to identify whether there are differences in the behaviour of firms with otherwise similar characteristics. This has a distinct advantage over the inference based on aggregate data in which ‘true’ differences in behaviour are potentially confounded by differences due to composition of the firms in the aggregate.

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