The Balance Sheet Channel of Monetary Policy Transmission: Evidence from the UK (original) (raw)

The Balance Sheet Channel of Monetary Policy Transmission: Evidence from the United Kingdom

Economica, 2009

This paper examines the sensitivity of investment to cash flow using a panel of UK firms in manufacturing with a view to shedding some light on the existence of a balance sheet channel or financial accelerator. In addition to examining the impact of cash flow in different subsamples based on company size or financial policy (dividend payouts, share issues and debt accumulation), we also investigate the extent to which investment becomes more sensitive to cash flow in periods of monetary tightness. To this end, we employ a monetary tightness indicator constructed for the UK using the narrative approach pioneered by Romer and Romer. The results provide some support for the view that UK firms show greater investment sensitivity to cash flow during periods of tight monetary policy.

Monetary policy transmission: Balance sheet channel and investment behavior of firms in Pakistan

Economic Journal of Emerging Markets

Purpose ─ This study investigates the relevance of the balance sheet channel of monetary policy transmission concerning non-financial firms at the Pakistan Stock Exchange (PSX), a firm-level data. Methods ─ This paper estimates a family of panel data regression models and constructs a dummy variable for monetary policy tightness. Findings ─ The result indicates a positive relationship between cash flows and investment during periods of monetary tightness. The impact on cash flows is visibly more pronounced than that of the quantitative effect of an increase in capital cost, which gives rise to a balance sheet channel. Three financial constraints, namely size, leverage, and dividend policy, are used to segregate firms into financially constrained and unconstrained firms. Implication ─ The results highlight the balance sheet channel impact on smaller firms' cash. The cash flows of highly leveraged firms were impacted more during the tight monetary policy periods and thereby were more prone to decline in investments. Results on constraints of dividend policy are, however, inconclusive. Originality ─ The paper contributes to the literature by investigating the relevance of the balance sheet channel of monetary policy transmission concerning non-financial firms using firm-level data. It also contributes to the literature by constructing a dummy variable to measure monetary policy tightness.

Investment, Finacial Factors and Cash Flow: Evidence From UK Panel Data

1989

In this paper we provide some econometric evidence on the impact of financial factors like cash flow, debt and stock measures of liquidity on the investment decisions of U. K. firms. These variables are introduced via an extension of the Q model of investment which explicitly includes agency/financial distress costs. We discuss if the significance of cash flow may be due to the fact that it proxies for output or because it is a better measure of market fundamentals than Q. Moreover we investigate if the effect of financial factors varies across different types of firms, according to size, age, and type of industry (growing and declining). We analise the determinants of the magnitude of the cash flow effect and explain why caution must be exercised in attributing inter-firm differences only to differences in the importance of agency or financial distress costs.

The Effect of Firm Cash Holdings on Monetary Policy

SSRN Electronic Journal, 2015

Firm cash holdings increased substantially from 1980 to 2013. The overall distribution of firm cash holdings changed in the same period. We study the implications of these changes for monetary policy. We use Compustat data and a model with financial frictions that allows the calculation of the monetary policy effects according to the distribution of cash holdings. We find that the interest rate channel of the transmission of monetary policy has become more powerful, as the impact of monetary policy over real interest rates increased. With the observed changes in firm cash holdings, the real interest rate takes 3.4 months more to return to its initial value after a shock to the nominal interest rate.

Investment and cashflow: New evidence

lse.ac.uk

We study the investment-cashflow sensitivities of U.S. firms from 1971-2009. Our tests extend the literature in several key ways and provide strong evidence that cashflow explains investment beyond its correlation with q. In simple OLS regressions, a dollar of current-and prior-year cashflow is associated with 0.53ofadditionalinvestmentforfirmsthataretheleastlikelytobeconstrainedand0.53 of additional investment for firms that are the least likely to be constrained and 0.53ofadditionalinvestmentforfirmsthataretheleastlikelytobeconstrainedand0.67 for firms that are the most likely to be constrained. Investment-cashflow sensitivities for the two groups drop to a conservatively estimated but still significant 0.32 and 0.63, respectively, after correcting for measurement error in M/B. Our results suggest that financing constraints and free cashflow problems are important for investment decisions.

Monetary Policy, Corporate Financial Composition and Real Activity

CESifo Economic Studies, 2006

This article addresses two fundamental questions about monetary policy, credit conditions and corporate activity. First, can we relate differences in the composition of debt between tight and loose periods of monetary policy to firm characteristics like size, age, indebtedness or risk? Second, do differences in companies' financial compositions matter for real activity of firms such as inventory and employment growth? The article offers some evidence from firms in the UK manufacturing sector which suggests that the composition of debt differs considerably with characteristics such as size, age, debt and risk, it also shows a significant effect from financial composition and cash flow to inventory and employment growth. (JEL codes: E32, E44, E51)

Monetary policy, cash holding and corporate investment: Evidence from China

A B S T R A C T This paper uses 13,766 firm-year observations between 2003 and 2013 from China to investigate the effects of monetary policy on corporate investment and the mitigating effects of cash holding. We find that tightening monetary policy reduces corporate investment while cash holdings mitigate such adverse effects. The cash mitigating role is especially significant for financially constrained firms, non-state-owned enterprises (non-SOEs) and those firms located in a less developed financial market. Cash holding also improves investment efficiency when monetary policy is tightening and tightening monetary policy enhances the 'cash-cash flow' sensitivity. Our empirical evidence calls for a critical evaluation on the monetary policies implemented in China which are less effective for state-owned enterprises. It also calls for a necessity for local government to further develop regional financial markets to protect vulnerable businesses, such as non-SOEs and financially constrained firms, from external shocks in order to maintain their sustainable growth and competitive advantages.

Monetary Policy and Corporate Credit Conditions: Accounting for Firm-Specific Characteristics

2002

This paper examines the relationship between UK firms' choices over bank-based and market-based finance under different monetary conditions. The evolving financial environment facing the corporate sector provides many nonbank external finance options available as an alternative to bank finance. The paper shows that firms distributed according to their type (asset size, rating etc) have differential access to bank lending. As monetary policy tightens weak firms are excluded from bank credit and will seek alternative external funding, such as non-bank external finance or trade credit. We intend to look at the external finance 'mix' using a panel of 16,000 UK firm records taken from the FAME database for the years 1990 through 1999. The paper provides evidence consistent with a credit channel by demonstrating that there are distributional implications from tightening monetary policy. Non-bank forms of external finance are close substitutes for certain types of firms who switch into these types of finance from bank lending.

Monetary Policy and Balance Sheets

IMF Working Papers, 2013

This paper evaluates the strength of the balance sheet channel in the U.S. monetary policy transmission mechanism over the past three decades. Using a Factor-Augmented Vector Autoregression model on an expanded data set, including sectoral balance sheet variables, we show that the balance sheets of various economic agents act as important links in the monetary policy transmission mechanism. Balance sheets of financial intermediaries, such as commercial banks, asset-backed-security issuers and, to a lesser extent, security brokers and dealers, shrink in response to monetary tightening, while money market fund assets grow. The balance sheet effects are comparable in magnitude to the traditional interest rate channel. However, their economic significance in the run-up to the recent financial crisis was small. Large increases in interest rates would have been needed to avert a rapid rise of house prices and an unsustainable expansion of mortgage credit, suggesting an important role for macroprudential policies.