Academic journal article Journal of Financial Management & Analysis

Impact of Monetary Policy and Firm Characteristics on Short-Term Financial Management Measures: Evidence from U.S. Industrial Firms

Academic journal article Journal of Financial Management & Analysis

Impact of Monetary Policy and Firm Characteristics on Short-Term Financial Management Measures: Evidence from U.S. Industrial Firms

Article excerpt


In this paper, we analyze the effects of monetary policy and firm characteristics on different measures of working capital management. More specifically, we use micro level U.S. manufacturing firm data, namely firm size, profitability, tangibility, marketto-book ratios, and leverage in conjunction with aggregate monetary policy to analyze the impacts on firms' short-term financial management measures.

We attempt to answer these three questions:

* What is the impact of monetary policy on firms' short-term financial management measures including net working capital, inventory turnover and receivables turnover?

* Do firm characteristics like size, profitability, tangibility, market-to-book ratio, and leverage help insulate firms from the impact of monetary policy?

* Since monetary policy affects financing conditions for firms, does it have a different impact on highly levered firms versus other firms?

Our results will have implications for policymakers as well as managers of firms and investors. How does monetary policy affect firms' operations? What kinds of firms are affected less (insulated more)? Does having more debt make the firm more prone to the impacts of monetary policy? Knowing the answers to these questions will help the Fed when planning its future actions. It will also help firm managers because they will know what kind of precautions they will need to take in advance of monetary policy actions. Investors would also benefit from this knowledge. Depending on their expectations for Fed's actions, they will be able to switch to another investment if they think that their current investment will be negatively affected.


A number of papers have looked at the "insulation hypothesis" whereby monetary policy is seen to affect firms' investments and their term structure of debt, but several factors insulate them from the transmission effects of monetary policy. Gander1 finds some evidence that U.S. industrial firms insulate themselves from the effects of monetary policy in their borrowing behavior, and the firms' retained earnings have a significant role in the insulation effect. In our paper, we look at possible insulation effects of monetary policy on short-term financial management ratios of firms due to factors such as firm size and leverage.

Bernanke and Blinder ( 1 992)2 and Gertler and Gilchrist (1993, 1994)1-4 have analyzed the existence and the degree of effectiveness of different lending channels (banks and nonbanks) and the transmission of monetary policy through the alternate sources of lending for aggregated corporate data. Bernanke ( 1993)5 reviewed the understanding of the macroeconomic role of credit or. more accurately, of the credit creation process. The paper noted that an alternative to this conventional view holds that the credit creation process, far from being a perfectly functioning machine, may sometimes be ineffective and even break down. According to Bernanke, the development of alternative credit sources will both reduce the Fed's influence on the volume of lending and increase the ability of borrowers to substitute away from bank loans. In our paper, we try t& identify firm characteristics that may "insulate" the firm from the transmission mechanism of the aggregate credit creation process.

Jeffrey Nilsen (1999)6 has looked at the behavior of trade credit, particularly at the possibility that wholesale and retail firms increase their use of trade credit when monetary policy tightens and bank loans become more difficult to obtain. We are interested in the behavior of firms' net working capital, inventory turnover and receivables turnovers when monetary policy is contractionary, and check whether certain firm characteristics help to insulate the firms from the effects of tighter monetary policy. Bernanke finds that monetary policy has a disproportionate effect on small firms with the implication that the burdens of disinflation are not evenly shared. …

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