Financial Constraints, Sectoral Heterogeneity, and the Cyclicality of Investment

By Cooper Howes

While investment in most sectors declines in response to a contractionary monetary policy shock, investment in the manufacturing sector increases. Using manually digitized aggregate income and balance sheet data for the universe of U.S. manufacturing firms, I show this increase is driven by the types of firms that are least likely to be financially constrained. A two-sector New Keynesian model with financial frictions can match these facts; unconstrained firms are able to take advantage of the decline in the user cost of capital caused by the monetary contraction, while constrained firms are forced to cut back.

I must confess I was not aware of this fact that manufacturing investment is countercyclical. This paper demonstrates also a nice automatic stabilizer from that sector. I wonder, though, whether the size of manufacturing matters in this regard, as a larger sector would not be able to take as easily advantage of lower capital costs.


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