Ruslana Datsenko (University of Oslo)

Monetary Policy Transmission and Firm-Level Volatility: Uncertainty Versus Risks

Abstract. I study the role of firm-level volatility and default risk in the transmission of monetary policy to investments in fixed assets. Empirically, I find that firms facing lower volatility decrease their investments by more after increase in interest rate than firms that face higher volatility. I demonstrate that this finding is due to two channels through which volatility determines monetary policy transmission. First, volatility increases default risk which increases the price of borrowed funds. Second, volatility increases firms hesitancy to invest (“real options” channel). In contrast with the earlier literature, I show that the real options rather than the default risk channel matters for the transmission of monetary policy. Moreover, I demonstrate the relevance of the two channels in a heterogeneous firm model with non-convex adjustment costs and default risk. I find that the channel through which the monetary policy transmission takes place — real options or risk premium — determines whether the monetary policy increases or decreases aggregate capital relative to a model without heterogeneity, adjustment costs, and financial frictions.