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How do firms’ financial conditions influence the transmission of monetary policy? A non-parametric local projection approach

Author

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  • Livia Silva Paranhos

    (Bank of England)

Abstract

How do monetary policy shocks affect firm investment? This paper provides new evidence on US non-financial firms and a novel non-parametric framework based on random forests. The key advantage of the methodology is that it does not impose any assumptions on how the effect of shocks varies across firms thereby allowing for general forms of heterogeneity in the transmission of shocks. My estimates suggest that there exists a threshold in the level of firm risk above which monetary policy is much less effective. Additionally, there is no evidence that the effect of policy varies with firm risk for the 75% of firms in the sample with higher risk. The proposed methodology is a generalisation of local projections and nests several common local projection specifications, including linear and nonlinear.

Suggested Citation

  • Livia Silva Paranhos, 2024. "How do firms’ financial conditions influence the transmission of monetary policy? A non-parametric local projection approach," Bank of England working papers 1100, Bank of England.
    • Handle: RePEc:boe:boeewp:1100
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    References listed on IDEAS

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    7. José Luis Montiel Olea & Mikkel Plagborg‐Møller, 2021. "Local Projection Inference Is Simpler and More Robust Than You Think," Econometrica, Econometric Society, vol. 89(4), pages 1789-1823, July.
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    Cited by:

    1. Philippe Goulet Coulombe & Karin Klieber, 2025. "Opening the Black Box of Local Projections," Papers 2505.12422, arXiv.org, revised Jul 2025.

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    More about this item

    Keywords

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    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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