Investment Finance and Monetary Policy in Europe (download PDF 264 Kb)

Alex Cobham

Abstract
This paper assesses the different investment responses to monetary policy and external financing of firms of different sizes in the main EMU member economies. The finding that smaller firms are more sensitive to tight monetary policy is confirmed by analysis of the determinants of their cost of capital. Further regression analysis (using a panel of balance sheet data) shows that the level of investment is highly dependent on the net sources of finance. Greater reliance on internal funds reduces investment for all sizes of firms, while long-term debt is more important for small and medium than large firms, but equity is more important for medium and large firms than for small. Cobham (2004) identified a shift in long-term debt financing towards large firms, but the results here suggest that the benefits of this are likely to be minimal while the costs in foregone investment could be substantial.

JEL Classification: G31, G32, L16.

Keywords : monetary policy; corporate investment; cost of capital; EMU; credit channel.