Tightening monetary policy and investment dynamics in the European Monetary Union: Firm- and country-level heterogeneity

We employ firm-macro matched data on small and medium-size enterprises in the European Monetary Union to study the investment response to tight monetary policy shocks. We show that firms with higher leverage and longer debt maturity are more negatively responsive to monetary restrictions. Capital structure significantly interacts with monetary policy transmission: a leverage ratio one percentage point larger than average is associated with a semi-elasticity of investment to a nominal interest rate hike approximately 8 % higher two years following the monetary shock. Firm-level heterogeneity proves to be more pronounced in the presence of long-term—rather than short-term—indebtedness. We further argue that the investment response to monetary contractions is heterogeneous not only with respect to the firm-level financial structure but also in relation to the country-specific financial and productive conditions. Specifically, we show that the investment semi-elasticity to rate hikes significantly increases in countries characterized by higher frictions in accessing the credit market and in countries featured by either a larger share of small-size firms or a larger share of intangible assets.