Business cycles, stock returns and the transmission channels of conventional and unconventional monetary policy

The zero-lower bound (ZLB) may constrain the ability of Federal Reserve (Fed) to influence financial markets and the economy. This note examines the effectiveness of the interest rate channel and the credit channel of conventional and unconventional monetary policy while accounting for business cycle fluctuations. We use intraday industry returns and a number of industry-specific and firm-specific indicators to capture the sensitivity of firms’ demand to interest rates (interest rate channel) and firms’ financial constraints (credit channel). Our results indicate a dramatic change in the effectiveness of the transmission channels across business cycles and across periods. We find that the interest rate channel operates equally well during recessions and expansions pre-ZLB, but that this channel has ceased to function during the ZLB regardless of the stage of the business cycle. In contrast, the credit channel operates only during recessions in the conventional period, while it has been remarkably effective during both recessions and expansions in the ZLB era.11We thank Stefania D’Amico, Emmanuel Lartey, Lin Yan, and conference participants of the Econometric Society Asia Meeting 2021, WEAI 2021, World Finance Conference 2022, and International Finance and Banking Society 2018 for helpful comments and suggestions. We gratefully acknowledge the support of the Faculty Research Grant of the College of Business and Economics, California State University, Fullerton.