A tale of two margins: monetary policy and capital misallocation

Abstract

This paper explores the impact of monetary policy on capital misallocation through its heterogeneous effects on firms. Using Spanish firm-level data covering the period 1999-2019, we show that an expansionary monetary policy shock leads to a decrease in capital misallocation, as measured by the within-industry dispersion of firms’ marginal revenue product of capital (MRPK). To analyse the mechanism behind this finding, we first explore the intensive margin and show that high-MRPK firms increase their investment and their debt financing relatively more than low-MRPK firms after monetary policy easing. We also document that a firm’s MRPK is a much stronger driver of its investment sensitivity to monetary policy than its age, leverage or cash. These findings suggest that MRPK is a good proxy for financial frictions. Second, we explore the extensive margin and show that monetary policy easing increases entry and decreases exit, although the effect is quantitatively small, and it does not lead to significant changes in the composition of high- and low-MRPK entrants or exiters. Overall, the evidence points to expansionary monetary policy decreasing capital misallocation mainly through the relaxation of financial frictions of incumbent, productive, constrained firms.