IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Firm size and monetary policy transmission : a theoretical model on the role of capital investment expenditures

  • K. Raabe
  • I. Arnold
  • C.J.M. Kool

This paper presents a dynamic investment model that explains differences in the sensitivity of small- and large-sized firms to changes in the money market interest rate. In contrast to existing studies on the firm size effects of monetary policy, the importance of firms as monetary transmission channel does not originate from credit market imperfections, but from size-related differences in the degree of investment irreversibility. The degree of investment irreversibility is determined by sunk capital investment expenditures. We show that size-related differences in sunk investment expenditures have two interdependent effects: they (i) affect the optimal investment behavior of small- and large-sized firms and (ii) account for differences in the interest rate sensitivity of smalland large-firm investment. We illustrate that sunk investment expenditures affect the region of zero and non-zero investment activity and, hence, the frequency at which large and small firms change investment regimes. Furthermore, sunk investment costs determine the extent to which small- and large-firm investment displays discrete jumps. We find that large firms change investment regimes less frequently than small firms and that swings in investment are more accentuated for large than for small firms. We illustrate that the response of small- and large-firm investment to monetary policy actions depends on the magnitude of the monetary policy shock.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://dspace.library.uu.nl/bitstream/handle/1874/37223/06-14.pdf
Download Restriction: no

Paper provided by Utrecht School of Economics in its series Working Papers with number 06-14.

as
in new window

Length: 38 pages
Date of creation: Sep 2006
Date of revision:
Handle: RePEc:use:tkiwps:0614
Contact details of provider: Postal: P.O. Box 80125, NL-3508 TC Utrecht
Phone: +31 30 253 9800
Fax: +31 30 253 7373
Web page: http://www.uu.nl/EN/faculties/leg/organisation/schools/schoolofeconomicsuse/Pages/default.aspx
Email:


More information through EDIRC

Order Information: Email:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Abel, Andrew B., 1980. "Empirical investment equations : An integrative framework," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 39-91, January.
  2. Elsas, Ralf & Krahnen, Jan Pieter, 1998. "Is relationship lending special? Evidence from credit-file data in Germany," Journal of Banking & Finance, Elsevier, vol. 22(10-11), pages 1283-1316, October.
  3. Gambacorta, Leonardo, 2008. "How do banks set interest rates?," European Economic Review, Elsevier, vol. 52(5), pages 792-819, July.
  4. Andrew B. Abel & Olivier J. Blanchard, 1983. "The Present Value of Profits and Cyclical Movements in Investment," NBER Working Papers 1122, National Bureau of Economic Research, Inc.
  5. Ivo J. M. Arnold & Evert B. Vrugt, 2004. "Firm Size, Industry Mix and the Regional Transmission of Monetary Policy in Germany," German Economic Review, Verein für Socialpolitik, vol. 5(1), pages 35-59, 02.
  6. Luca Dedola & Francesco Lippi, 2000. "The monetary transmission mechanism; evidence from the industries of five OECD countries," Temi di discussione (Economic working papers) 389, Bank of Italy, Economic Research and International Relations Area.
  7. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. Bond, Stephen & Meghir, Costas, 1994. "Dynamic Investment Models and the Firm's Financial Policy," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 197-222, April.
  9. Gerald Carlino & Robert Defina, 1998. "The Differential Regional Effects Of Monetary Policy," The Review of Economics and Statistics, MIT Press, vol. 80(4), pages 572-587, November.
  10. Kumar, Krishna B & Rajan, Raghuram G & Zingales, Luigi, 1999. "What Determines Firm Size?," CEPR Discussion Papers 2211, C.E.P.R. Discussion Papers.
  11. James D. Adams, 1997. "The Structure of Firm R&D and the Factor Intensity of Production," NBER Working Papers 6099, National Bureau of Economic Research, Inc.
  12. Alan Carruth & Andy Dickerson & Andrew Henley, 1998. "What Do We Know About Investment Under Uncertainty?," Studies in Economics 9804, School of Economics, University of Kent.
  13. Tore Ellingsen & Ulf Soderstrom, 2001. "Monetary Policy and Market Interest Rates," American Economic Review, American Economic Association, vol. 91(5), pages 1594-1607, December.
  14. Timo Baas & Mechthild Schrooten, 2006. "‘Relationship Banking and SMEs: A Theoretical Analysis’," Small Business Economics, Springer, vol. 27(2), pages 127-137, October.
  15. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  16. Andrew B. Abel & Janice C. Eberly, . "A Unified Model of Investment Under Uncertainty," Rodney L. White Center for Financial Research Working Papers 14-93, Wharton School Rodney L. White Center for Financial Research.
  17. Gerald Carlino & Robert DeFina, 1997. "The differential regional effects of monetary policy: evidence from the U.S. States," Working Papers 97-12, Federal Reserve Bank of Philadelphia.
  18. Ricardo J. Caballero & John V. Leahy, 1996. "Fixed Costs: The Demise of Marginal q," NBER Working Papers 5508, National Bureau of Economic Research, Inc.
  19. Gerald A. Carlino & Robert H. DeFina, 1999. "Do states respond differently to changes in monetary policy?," Business Review, Federal Reserve Bank of Philadelphia, issue Jul, pages 17-27.
  20. Ehrmann, M., 2000. "Firm Size and Monetary Policy Transmission - Evidence from German Business Survey Data," Economics Working Papers eco2000/12, European University Institute.
  21. Abel, Andrew B. & Eberly, Janice C., 1997. "An exact solution for the investment and value of a firm facing uncertainty, adjustment costs, and irreversibility," Journal of Economic Dynamics and Control, Elsevier, vol. 21(4-5), pages 831-852, May.
  22. von Kalckreuth, Ulf, 2002. "Monetary Transmission in Germany: New Perspectives on Financial Constraints and Investment Spending," Royal Economic Society Annual Conference 2002 179, Royal Economic Society.
  23. Lensink, Robert & Steen, Paul van & Sterken, Elmer, 2000. "Is size important for the investment-uncertainty relationship? : an empirical analyses for Dutch firms," Research Report 00E03, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  24. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
  25. Stephen D. Oliner & Glenn D. Rudebusch, 1994. "Is there a broad credit channel for monetary policy?," Working Paper Series / Economic Activity Section 146, Board of Governors of the Federal Reserve System (U.S.).
  26. Barnett, Steven A. & Sakellaris, Plutarchos, 1998. "Nonlinear response of firm investment to Q:: Testing a model of convex and non-convex adjustment costs1," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 261-288, July.
  27. Nicholas Bloom & Steve Bond & John Van Reenen, 2001. "The dynamics of investment under uncertainty," IFS Working Papers W01/05, Institute for Fiscal Studies.
  28. Bond, Stephen & Van Reenen, John, 2007. "Microeconometric Models of Investment and Employment," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 65 Elsevier.
  29. Harhoff, Dietmar & Korting, Timm, 1998. "Lending relationships in Germany - Empirical evidence from survey data," Journal of Banking & Finance, Elsevier, vol. 22(10-11), pages 1317-1353, October.
  30. Marisa Ramírez Alesón & Manuel Espitia Escuer, 2002. "The impact of product diversification strategy on the corporate performance of large Spanish firms," Spanish Economic Review, Springer, vol. 4(2), pages 119-137.
  31. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series 0114, European Central Bank.
  32. Trautwein, Hans-Michael, 2000. " The Credit View, Old and New," Journal of Economic Surveys, Wiley Blackwell, vol. 14(2), pages 155-89, April.
  33. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  34. Timothy Erickson & Toni M. Whited, 2000. "Measurement Error and the Relationship between Investment and q," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 1027-1057, October.
  35. Gerald A. Carlino & Robert DeFina, 1998. "Monetary policy and the U.S. and regions: some implications for European Monetary Union," Working Papers 98-17, Federal Reserve Bank of Philadelphia.
  36. Hjalmar Böhm & Michael Funke, 1999. "The Uncertainty-Investment Relationship," Quantitative Macroeconomics Working Papers 19903, Hamburg University, Department of Economics.
  37. Vivek Ghosal & Prakash Loungani, 2000. "The Differential Impact of Uncertainty on Investment in Small and Large Businesses," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 338-343, May.
  38. Cabral, Luis, 1995. "Sunk Costs, Firm Size and Firm Growth," Journal of Industrial Economics, Wiley Blackwell, vol. 43(2), pages 161-72, June.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:use:tkiwps:0614. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marina Muilwijk)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.