Stock Market's Assessment of Monetary Policy Transmission: The Cash Flow Effect

Abstract

We show that firm liability structure and associated cash flows matter for firm behavior and that financial market participants price stocks accordingly. Stock price reactions to monetary policy announcements depend on the type and maturity of debt issued by the firms and the forward guidance provided by the Fed, both at and away from the zero lower bound. Further, the marginal stock market participant knows the current liability structures of firms and does not rely on rules of thumb. The cash flow exposure at the time of monetary policy actions predicts future investment, assets, and net worth, clearly violating the Modigliani-Miller theorem.AN INFLUENTIAL BRANCH OF THE MACROFINANCE literature focuses on financial conditions to amend standard macroeconomic models to better fit the observed effects of monetary policy on real activity and helps explain why financial markets are so important and financial crises so destructive. These models, in which the Modigliani-Miller theorem fails, collectively require cash in the firm to be more valuable than cash outside it. While the financial accelerator models are compelling, the literature remains thin on empirical evidence due to the difficulty of establishing identified effects. Similarly, our understanding of the effects of monetary policy on stock prices is also

Green Transmission: Monetary Policy in the Age of ESG

“…This may reflect the fact that conventional monetary policy was constrained in the ZLB period, which may have led to less powerful responses in asset prices. 23 Second, Table 9 performs a falsification test in line with Gürkaynak et al (2019), which looks at the two-day asset price changes up to 10 days before the FOMC announcements and finds no relationship between monetary policy shocks and firm-level greenness. Thus, it is not the case that green firms always behave differently from their brown counterparts for some 22 Removing the industry-by-time fixed effects reveals that in response to a contractionary monetary policy shock of 100 bp average asset prices fall by 19%, whereas in response to an expansionary monetary policy shock of 100 bp the average stock prices increase by 16%.…”

“…However, while the Kuttner surprise is really effective at capturing the monetary policy stance in the pre-GFC crisis period, it not as relevant in the post-GFC period. This is be-cause the post-GFC period is characterised by monetary policy surprises concerning the future course of policy rates, and not changes in the immediate policy (Gürkaynak et al, 2019).…”

“…Consistent with research on firm balance sheet heterogeneity and monetary policy shocks, I also account for differences in firm profitability, cash holdings (liquidity), market-to-book ratio (growth vs. value stocks), asset maturity. retained earnings, short term and long term debt and dividends per share (Cloyne et al, 2018;Gürkaynak et al, 2019;Ippolito et al, 2018;Lakdawala and Moreland, 2021).…”

“…∆p i,t denotes the percentage change in the stock price of firm i at time t (log difference of the closing quotes of stock prices the day before and the day after an FOMC announcement), ε m t is the BRW monetary policy shock, g i,t−1 is a firm i's environmental score computed as described in Section 2.1. Drawing from previous work by Gürkaynak et al (2019) and Ottonello and Winberry (2020), Z i,t−1 is a vector of controls that include size, profitability, book leverage, market-to-book ratio, cash holdings, short term liabilities, retaining earnings, dividend per share and distance to default.…”

The credit channel of monetary transmission in the US: is it a bank lending channel, a balance sheet channel, or both, or neither?

“…Again, their empirical results validate the cash-flow channel, showing that its working was not altered by the ZLB. Finally, Gurkaynak et al (2021) use a measure of financial constraint applicable to listed US firms to test whether financial frictions drive the real effects of monetary policy and report that financial constraints indeed matter and that more constrained firms show large sensitivity to cash flows triggered by monetary policy shocks.…”