Beatriz Gonzales, Banco de España

"Firm Heterogeneity, Capital Misallocation and Optimal Monetary Policy"

Abstract

We analyze monetary policy in a New Keynesian model with heterogeneous firms and financial frictions. Firms differ in their productivity and net worth and face collateral constraints that cause capital misallocation. TFP endogenously depends on the time-varying distribution of firms. A monetary expansion increases the investment of constrained firms with a high marginal revenue product of capital (MRPK) relatively more than that of low-MRPK ones, crowding out the latter and increasing TFP. We provide empirical evidence based on Spanish granular data supporting this mechanism. This has important implications for optimal monetary policy design. First, a central bank without pre-commitments engineers an unexpected monetary expansion to increase TFP in the medium run. Second, the divine coincidence holds after a demand shock. Third, if nominal rates are constrained by the zero lower bound, the optimal policy prescribes that rates should remain low for much longer than under complete markets.

Contact person: Jeppe Druedahl