Asset price channel

How does monetary policy affect investment in the euro area?

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Thursday, November 26, 2020

Macroeconomics, Money, Economy, Macroeconomic policy, Monetary economics, Monetary policy, Public finance, Credit channel, Asset price channel

By Elena Durante, Annalisa Ferrando, and Philip Vermeulen[1] We set out to analyse the monetary policy transmission mechanism by documenting how the annual investment of more than one million firms in Germany, Spain, France and Italy responded to monetary policy shocks between 2000 and 2016.

Key Points:

By Elena Durante, Annalisa Ferrando, and Philip Vermeulen[1] We set out to analyse the monetary policy transmission mechanism by documenting how the annual investment of more than one million firms in Germany, Spain, France and Italy responded to monetary policy shocks between 2000 and 2016.
This confirms that monetary policy is affecting firms investment through two different channels.
On the other hand, as young firms are more likely to face financing constraints, their stronger than average reaction can be explained by the balance sheet channel of monetary policy transmission.

Introduction

Monetary policy affects firms investment through both an interest rate channel and a balance sheet channel.
First, through the interest rate channel, monetary policy can affect firms demand for capital as an input into the production process.
This is because interest rates affect decisions on saving or investing and can boost aggregate demand.
The external finance premium is the difference between the cost of borrowing funds externally and generating them internally.
Another reason why the impact on firms investment varies is the height of the external finance premium they face.
This article explains how we analyse these two channels of monetary policy transmission in the euro area, i.e.
by documenting the heterogeneous reaction of firms investment to monetary policy shocks (Durante, Ferrando and Vermeulen, 2020).

Data and estimation method

We use firm-level data from the four largest economies in the euro area (Germany, Spain, France and Italy) to construct a large and rich dataset covering more than one million firms throughout 2000-16.
As a proxy for the euro area policy rate we use the high-frequency monetary policy shock series from Jarociski and Karadi (2020).
Since firm-level investment data are annual, we construct an annual monetary policy shock data series by aggregating the monthly shocks into twelve-month totals.
We split the firms into different groups, based on what we already know about firms being affected differently by different transmission channels.
Younger firms have shorter credit histories and should therefore be more vulnerable than older ones to any tightening of credit conditions.

Findings

how firms investment reacts to a tightening of monetary policy.
The investment rate of the average firm does not react initially, but drops by 3.4 percentage points in the year following the monetary policy shock.
In the second year after the shock, the investment rate remains at this lower level.
Chart 1 Average investment reaction to a monetary policy shock

firms below 10 years of age, react more strongly to a surprise than the average firm.
Similarly, firms that produce durables react more strongly than firms providing services.
Chart 2 illustrates that a combination of these characteristics leads to substantial differences in firms reactions to monetary policy.
One year after the surprise, the investment rate of young firms in the durables sector drops by 5.0 percentage points.
[2] Mature firms, between 10 and 20 years of age, exhibit a reaction within those two extremes (4.4 percentage points for mature firms producing durables and 2.9 percentage points for mature firms providing services).

Conclusions

In the aftermath of a monetary policy shock, firms that produce durables cut back their investment more than firms providing services.
Young firms also react more, indicating that the balance sheet channel of monetary policy is having an impact.
Ultimately, these findings provide a deeper understanding of the transmission of euro area monetary policy to the real economy.
They point to important differences across firms a feature that is not yet routinely embedded in the standard macroeconomic models.

References

Benoît Cœuré: Monetary policy and climate change

Retrieved on:

Friday, November 9, 2018

Economy, Macroeconomics, Money, Monetary policy, Public finance, Macroeconomic policy, Monetary inflation, Central bank, Inflation, Price stability, Asset price channel, Interaction between monetary and fiscal policies

Monetary policy and climate changeSpeech by Benoît Cœuré, Member of the Executive Board of the ECB, at a conference on “Scaling up Green Finance: The Role of Central Banks”, organised by the Network for Greening the Financial System, the Deutsche Bundesbank and the Council on Economic Policies, Berlin, 8 November 2018[1] Increasing weather extremes, rising sea levels and Arctic melting are now clearly visible consequences of human-induced warming.

Key Points:

Monetary policy and climate change

Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at a conference on “Scaling up Green Finance: The Role of Central Banks”, organised by the Network for Greening the Financial System, the Deutsche Bundesbank and the Council on Economic Policies, Berlin, 8 November 2018

[1] Increasing weather extremes, rising sea levels and Arctic melting are now clearly visible consequences of human-induced warming.
The Financial Stability Boards Task Force on Climate-related Financial Disclosures published its first status report just a few weeks ago.

Climate change and the monetary policy strategy

To appreciate how climate change may affect monetary policy, it is useful to first recall the basic principles of how central banks decide on their actions.
Broadly speaking, implementing monetary policy is the practice of identifying the nature, persistence and magnitude of the shocks hitting our economy.

The impact of climate change on monetary policy

This meant that central bankers thought the horizon of climate change was extending well beyond the one of monetary policy.
That is, climate change is likely to affect monetary policy one way or the other whether it is left unchecked or humankind rises to the climate change challenge.
On this trajectory, climate change is likely to affect the conduct of monetary policy in three important ways.

Relative prices and inflation expectations in the transition towards a low-carbon economy

[18] In other words, a lasting shift in the energy mix can be expected to persistently change relative prices.
Although such a change should in principle not bear consequences for monetary policy, if large and persistent enough, it could feed into expectations and affect aggregate inflation.

Greening monetary policy implementation

So, the implications for the conduct of monetary policy could be substantial.
We thus need to carefully weigh all relevant considerations and determine the actions that would be both legal and effective in promoting environmental protection without interfering with the main objective of the ECBs monetary policy under the Treaty, which is price stability.
We have also joined the Central Banks and Supervisors Network for Greening the Financial System.

Central bank asset portfolios differ in their ability to support sustainable investment

The broad investment universe and longer-term investment horizon allow us to pursue a sustainable investment policy based on selective exclusion and proxy voting guidelines.
And, together with our external asset managers, we are considering broadening the options for ECB staff to invest in sustainable financial products.
And we could potentially expand our investment universe to other asset classes where the ESG-compliant investment space is broader.