The Investment Channel of Monetary Policy: Disentangling Firm Heterogeneity

To study monetary policy transmission at the firm level, researchers typically consider heterogeneity along a small number of firm characteristics, such as size or leverage. We instead estimate the full distribution of firms’ investment responses to monetary policy, using a clustering regression framework. Our novel approach captures multidimensional and unobservable heterogeneity across firms and time. We find that investment by most firms in most time periods responds little to monetary policy. Only about 5% of firm-time observations are associated with a strong response. We then investigate the sources of heterogeneity ex post. We find that most of the variation in investment sensitivity arises within firms over time. Although several firm characteristics predict responsiveness to monetary policy, the majority of heterogeneity remains unexplained by firm observables. We demonstrate that our empirical estimates provide new targets for disciplining structural models of firm heterogeneity.