How do firms’ financial conditions influence the transmission of monetary policy? A non-parametric local projection approach

Livia Paranhos

Journal of Econometrics, 2025, vol. 249, issue PC

Abstract: How do monetary policy shocks affect firm investment? This paper provides new evidence on US non-financial firms and a novel non-parametric framework based on random forests. The key advantage of the methodology is that it does not impose any assumptions on how the effect of shocks varies across firms thereby allowing for general forms of heterogeneity in the transmission of shocks. My estimates suggest that there exists a threshold in the level of firm risk above which monetary policy is much less effective. Additionally, there is no evidence that the effect of policy varies with firm risk for the 75% of firms in the sample with higher risk. The proposed methodology is a generalization of local projections and nests several common local projection specifications, including linear and nonlinear.

Keywords: Local projection; Impulse response estimation; Nonlinearity; Heterogeneity; Firm investment (search for similar items in EconPapers)
JEL-codes: C14 C23 E22 E52 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:249:y:2025:i:pc:s0304407624002318

DOI: 10.1016/j.jeconom.2024.105886

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