Since the 2008 global financial crisis, firms’ funding patterns have changed. Notably, there has been a significant shift toward more market-based finance with active issuances of debt securities by non-financial corporations (Darmouni and Papoutsi 2022). In the euro area, the share of bond financing rose from 9% in 2007 to 17% in 2021, while in France it increased from 19% to 29% over the same period. In a recent study (Alder et al. 2024), we use firm-level data to investigate the quantitative implications of firms’ debt structure on the transmission of monetary policy to investment.
ECB interest rate policy and bond liquidity shocks
According to the bank lending channel, policy rate increases lead to more restrictive bank credit. In these circumstances, bond markets can provide an alternative to bank financing (Kashyap et al. 1993). If monetary tightening decreases the creation of bank loans but stimulates corporate bond issuance, then the effectiveness of monetary policy could be hampered. However, as Darmouni et al. (2020) argue, when bond finance frictions are high, a bond-lending channel can potentially dominate and firms with more bond financing would be more negatively affected by monetary tightening.
The central bank can affect investment through interest rate policy but also through liquidity conditions, as these can influence lending and borrowing decisions. We capture the liquidity effects of monetary policy shocks using movements in the French-German 10-year sovereign rate spread around ECB announcements (data from Altavilla et al. 2019), affected particularly by unconventional monetary policies. We show that this shock is significantly correlated with liquidity in bond markets and label it ‘bond liquidity shock’.
Unconventional policy easing, such as asset purchases, can reduce risk premia on debt securities and stimulate corporate bond issuance more than bank lending. Thereby, interest rate policy and bond liquidity shocks can have different effects on the investment of non-financial corporations depending on the firm’s debt structure.
In what follows, we show the average effect of interest rate policy and bond liquidity shocks on French firms’ investment and the role of the corporate debt structure in monetary policy transmission.
ECB monetary policy tightening reduces French firms’ investment
We examine the effect of monetary policy shocks using yearly firm-level data on French companies from FIBEN, the Banque de France credit register. Following the literature studying the impact of monetary policy shocks using high-frequency identification (Gertler and Karadi 2015, Jarocinski and Karadi 2018, Altavilla et al. 2019b), we rely on high-frequency surprises around ECB announcements to identify monetary policy shocks. These surprises are based on changes in the risk-free yield for maturities up to one year (‘conventional monetary policy shock’) and changes in the 10-year sovereign spread between French and German bonds (‘bond liquidity shock’). To capture the time profile of the investment response, we use panel local projections (Jordà 2005).
Figure 1 shows the impulse response function, i.e. at each horizon (from 1 to 5 years) of the estimated average firm-level effect, in percentage points, of an upward surprise of 100 basis points for each shock on a firm’s net investment rates. The conventional monetary policy shock (left panel) has an economically and statistically significant negative effect in the first three years after the shock. The bond liquidity shock (right panel) is insignificant in the first two years but decreases French firms’ investment starting from the third year after the shock.
Figure 1 Average response of investment to conventional monetary policy and bond liquidity shocks
Notes: Average response of investment to conventional monetary policy and bond liquidity restrictive shocks. Red dotted lines correspond to 95% confidence intervals.
Source: Alder et al. (2024).
Corporate debt structure and monetary policy transmission
To evaluate the role of the corporate debt structure, we interact monetary policy shocks with the firm’s individual lagged share of bond debt, allowing the responses of firm investment to vary depending on their debt structure. Figure 2 shows the response for these interaction variables, where the point estimates can be interpreted as the difference in reaction of investment ratios between a firm that borrows using only corporate bonds and a firm that borrows only via bank loans. As the left-hand graph indicates, after a contractionary conventional monetary policy shock, the higher the share of market debt of a firm, the less its investment falls. On the other hand, after a contractionary bond liquidity shock, the higher the market debt share of a firm, the more its investment falls.
Thus, monetary policy transmission to firm investment is a function of each firm’s share of bond debt and the specific type of monetary policy implemented. Interest rate policy has a stronger impact on firm investment when the firm is more reliant on bank loans, while monetary policies that increase liquidity in bond markets (such as quantitative easing) have a stronger effect when firm financing is more market-based.
Figure 2 Relative response of investment to conventional monetary policy and bond liquidity shock depending on firms’ bond share
Notes: Response of investment to conventional monetary policy and bond liquidity shocks interacted with the lagged bond share. An increase means that firms relying more on bonds are affected less by the shock.
Source: Alder et al. (2024).
Investigating the channel
We explore the transmission channel in more detail using aggregate monthly data. In Figure 3, we show the response of bank-market spreads, defined as the difference between bank loan rates and yields on corporate bonds. As conventional monetary policy contracts, the spread falls in the short run but quickly becomes persistently positive. The timing of the response is consistent with a narrative that the pass-through to bond market yields is faster than to bank rates (Lane 2022). The long-run response confirms that conventional monetary policy has a stronger pass-through to bank loan rates relative to bond yields (Schnabel 2021) and explains the greater drop in investment for firms more dependent on banks.
Figure 3 Response of bank-market spread to conventional monetary policy and bond liquidity shocks
Notes: Response of bank-market spread to conventional monetary policy and bond liquidity shocks. Smooth Local Projections (Barnichon and Brownlees 2019). Red dotted lines: 95% confidence intervals.
Source: Alder et al. (2024).
The right-hand panel of Figure 3 shows that after a contractionary bond liquidity shock, the relative cost of bonds compared to bank loans increases, indicating that the transmission of bond liquidity to funding costs is stronger for market debt. This is consistent with the higher investment reduction for firms relying more on bonds, which we showed in Figure 2.
Figure 4 shows that the response of the new issuance flows of loans and bonds is consistent with the result on prices. Conventional monetary policy shocks have a relatively stronger effect on the new issuance of bank credit, while bond liquidity shocks have a relatively stronger effect on the issuance of market debt.
Figure 4 Response of bank share of new issuance to conventional monetary policy and bond liquidity shocks
Notes: Response of the ratio of new bank loans to total new debt issued, i.e. bonds and loans. Smooth Local Projections (Barnichon and Brownlees 2019). 95% confidence intervals in red.
Source: Alder et al. (2024).
The heterogeneous impact of monetary policy on firms’ investment has important implications for monetary policy transmission. Investment of large non-financial corporations with better access to capital markets could be more affected by quantitative tightening, while the investment of smaller, bank-dependent firms would decrease more after conventional tightening. When using a single tool, monetary policy can have uneven effects across different groups of firms, depending on which tool is used. On the upside, policy can be more targeted when there are specific issues with one type of funding.
References
Alder, M, N Coimbra, and U Szczerbowicz (2024), “Corporate debt structure and heterogeneous monetary policy transmission”, CEPR Discussion Paper 18787.
Altavilla, C, L Brugnolini, R Gürkaynak, R Motto, and G Ragusa (2019a), “The euro area monetary policy event-study database”, VoxEU.org, 3 October.
Altavilla, C, L Brugnolini, R Gürkaynak, R Motto, and G Ragusa (2019b), “Monetary policy in action: Multiple dimensions of ECB policy communication and their financial market effects”, VoxEU.org, 4 October.
Barnichon, R, and C Brownlees (2019), “Impulse response estimation by smooth local projections”, Review of Economics and Statistics 101(3): 522–30.
Darmouni, O, O Giesecke, and A Rodnyansky (2020), “Credit during a crisis: The bond lending channel of monetary policy”, VoxEU.org, 20 May.
Darmouni, O, and M Papoutsi (2022), “Europe’s growing league of small corporate bond issuers: New players, different game dynamics”, VoxEU.org, 8 July.
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Jordà, Ò (2005), “Estimation and inference of impulse responses by local projections”, American Economic Review 95(1): 161–82.
Kashyap, A K, J C Stein, and D W Wilcox (1993), “Monetary policy and credit conditions: Evidence from the composition of external finance”, American Economic Review 83(1): 78–98.
Lane, P R (2022), “The transmission of monetary policy”, speech at the 7th SUERF - CGEG|Columbia|SIPA - EIB - Société Générale Conference “EU and US Perspectives: New Directions for Economic Policy”, New York, 11 October.
Schnabel, I (2021), “The rise of non-bank finance and its implications for monetary policy transmission”, speech at the Annual Congress of the European Economic Association (EEA), Frankfurt am Main, 24 August.
