Central Bank Communication, Financial Frictions and Investment Decisions
Year: 2025
Type: article
Abstract: I study the role of financial positions in the transmission of Fed information to investment. Central bank communication influence firms’ expectations and stimulate investment, but its aggregate impact hinges on firms’ financial positions. In the data, low-leverage firms invest nearly twice as much as high-leverage firms following Fed information shocks, consistent with easier access to credit markets and borrowing. To assess the aggregate implications, I augment a heterogeneous-firm model with financial frictions and default risk to include a role for Fed information. The model shows that Fed information amplifies aggregate investment volatility by around 10 percent, but its effectiveness is dampened by leverage heterogeneity, which reduces the aggregate response by about 20 percent. Moreover, while Fed communication is most powerful in recessions, its aggregate impact is dampened when credit conditions are tight. These results suggest that forward guidance is most effective when complemented by credit policy.
DOI: 10.13016/m2tpni-hjtr
Authors: Pollio, Luigi, Terry, Stephen J.
Language: English
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W7102758629
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