Non-technical summary of ESM Working Paper 61 "Monetary policy, firm heterogeneity, and the distribution of investment rates"

One of the most important transmission channels of monetary policy to the real economy is via the investment decisions of firms. Yet, it is well-known that most firms do not regularly invest small amounts, but rather infrequently make big investments. This feature of firm-level investment behaviour is called lumpy investment.

This paper studies the role of lumpy investment for the transmission of monetary policy, its impact on aggregate investment, and the heterogeneous effects across young and old firms. When interest rates fall, aggregate investment rises not only because some firms increase the size of their investments, but also because more firms decide to make an investment at all. This mechanism, referred to as the extensive margin investment channel, is evidenced by a larger number of firms making big investments and a smaller number of firms not investing at all after expansionary monetary policy actions. In addition, we document that young firms are more likely to change their investment decision in response to monetary policy than old firms. This is because young firms are more interested in investing than old firms, since young firms are typically small and want to grow. Hence, they can more easily be induced to make a big investment. Old firms, in contrast, have often reached their desired size and are not interested in making big investments.

Our findings have important implications for policymakers. First and foremost, they show that interest rate cuts are particularly effective at boosting private investment when many firms are already interested in making an investment. This tends to be the case during economic upswings, when firms anticipate strong demand for their products and thus want to build production capacities, and when there is a high number of young firms eager to invest. Considering these findings can enhance policymakers' ability to tailor monetary policy measures towards achieving the desired impact on investment.