Monetary policy shock, financial frictions and heterogeneous firms

Abstract

This paper examines the influence of financial constraints on the transmission of monetary policy shocks across heterogeneous firms. To this end, we develop a Dynamic Stochastic General Equilibrium (DSGE) model incorporating firm heterogeneity, nominal rigidity, and financial frictions. Financial constraints hinder firms from expanding production, even under expansionary monetary policy shocks. This dynamic discourages the production of competitive firms and exerts downward pressure on factor prices, leading to the proliferation and entry of less efficient firms. The prevalence of these inefficient firms becomes more significant in economies with higher granularity, where the withdrawal of large firms from the market opens up space for less productive smaller non-producers.