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Firm Liquidity and the Transmission of Monetary Policy

Author

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  • Margherita Bottero

    (Bank of Italy, Economic Outlook and Monetary Policy Directorate)

  • Stefano Schiaffi

    (Bank of Italy, Economic Outlook and Monetary Policy Directorate)

Abstract

We study the impact of firms’ cash balances on the supply of bank credit and on the transmission of monetary policy through the bank lending channel. We show that banks supply cheaper credit to more liquid firms, in line with the pledgeability of cash and with its role in the loan negotiation process. Furthermore, we provide evidence that the transmission of monetary policy is weakened by firms’ liquidity balances. A monetary policy impulse alters the slope of the risk-free yield curve, which in turn changes the opportunity cost of holding cash-like assets. This leads firms to decrease their liquidity holdings after a steepening, or, alternatively, to increase them after a flattening. As a result, firms’ negotiation power declines after a policy rate cut, allowing banks to dampen the pass-through of the easing. Similarly, firms end up with larger cash balances after a tightening and are able to negotiate a lower pass-through.

Suggested Citation

  • Margherita Bottero & Stefano Schiaffi, 2025. "Firm Liquidity and the Transmission of Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 21(2), pages 37-76, April.
    • Handle: RePEc:ijc:ijcjou:y:2025:q:2:a:2
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