The investment decisions of firms is a key channel for the transmission of monetary policy. Yet, most firms invest infrequently and when they do, they spend large amounts. This column shows that monetary policy stimulates investment not only by affecting how much firms invest, but also whether they invest at all. The latter channel is particularly powerful among firms seeking to grow and already inclined to invest, such as young firms. Therefore, ‘lumpy’ investment behaviour implies that monetary policy is particularly effective in stimulating the economy when many firms are inclined to invest: in cyclical booms, but also in times with high business dynamism and many young and growing firms.
Monetary policy actions impact the economy with long and variable lags (Aruoba and Drechsel 2024). These lags make it crucial for policymakers to anticipate the aggregate effects that their actions will have. This task is complicated by the fact that the impact of monetary policy actions can vary over time, depending on the state and characteristics of the economy. For example, the state of the business cycle (Tenreyro and Thwaites 2016), firms’ financial conditions (Ottonello and Winberry 2020) and their debt structure (Alder et al. 2024), but also mortgage rate systems (Rebelo et al. 2018) determine the effectiveness of monetary policy. In a recent study, we show that firms’ lumpy investment behaviour makes the effectiveness of monetary policy vary across firms and therefore over time (Gnewuch and Zhang 2025). Monetary policy is particularly effective in stimulating investment among firms that are already inclined to make an investment. Therefore, not only the state of the business cycle, but also long-run trends such as the decline in business dynamism and share of young firms, shape the impact of monetary policy because they determine how many firms are inclined to invest.
What is ‘lumpy investment’?
Understanding fluctuations in aggregate investment as well as the investment channel of monetary policy requires understanding investment behaviour at the firm level. A central feature is that firm investment is ‘lumpy’. Most firms do not invest a similar-sized amount in every quarter, but rather invest infrequently, and if they do, they spend a large amount. Hence, firms ‘lump together’ their investment expenditure. This behaviour reflects that most investments incur fixed costs, such as planning costs, or are indivisible. By investing infrequently, firms economise on these fixed costs (Caballero et al. 1995).
Figure 1 showcases this lumpy investment behaviour, using firm-level investment data from public firms in the US (blue bars). In a given quarter, most firms invest a small amount or not at all, with almost half of firms choosing an investment rate between 0% and 4% of their existing capital stock (orange box). At the same time, some firms make very big investments, choosing investment rates even above 30%. Moreover, there are only very few negative investment rates, which arise when firms sell some of their capital.
Figure 1 The distribution of investment rates on average and after an expansionary monetary policy shock
Monetary policy affects firms’ decision whether to invest at all
Understanding the investment channel of monetary policy is essential for policymakers because investment is a sizeable and the most volatile component of aggregate GDP. To this end, the literature has extensively studied the effect of monetary policy on the average investment rate (Christiano et al. 2005). However, the average investment rate can change either because all firms change their investment rates equally – resulting in a shift in the distribution of investment rates – or because few firms change their investment rates by a lot – altering the shape of the distribution.
Figure 1 shows that an expansionary monetary policy shock changes the shape of the distribution of investment rates (red bars). At the peak effect of the shock, there are fewer small investment rates (orange box) and more large investment rates (green box). This evidence is consistent with lumpy investment and a sizeable investment channel along the extensive margin. That is, monetary policy not only affects how much firms invest (intensive margin), but also whether they make a large investment at all (extensive margin). A back-of-the-envelope calculation suggests that about 60% of the effect of monetary policy on the average investment rate is explained by more firms choosing to make a large investment, while only about 40% is explained by the intensive margin.
Young firms are more easily induced to make a large investment
Monetary policy has heterogeneous effects on the investment rates of various groups of firms. Firm size, age, leverage, and liquidity have all been shown to matter for firms’ responsiveness to monetary policy (Gertler and Gilchrist 1994, Ottonello and Winberry 2020, Jeenas 2023, Cloyne et al. 2023). These are important findings that help to understand the transmission of monetary policy and when it is particularly effective.
Figure 2 shows that the extensive margin investment channel is much stronger among young firms than among old firms. In response to an expansionary monetary policy shock, the share of firms making a large investment increases more among young firms (green boxes). The difference is particularly evident among very big investment rates above 28% (rightmost bars), which increase substantially among young firms, but barely among old ones. At the same time, the share of firms investing close to nothing falls more among young firms (orange boxes).
Figure 2 The extensive margin investment channel is stronger among young firms than among old firms
Note: Young (old) firms are less (more) than 15 years old.
This heterogeneous effect of monetary policy along the extensive margin highlights an important difference between young and old firms. Young firms are on average small and want to grow, while many old firms have already reached their desired size. Therefore, young firms are more inclined to invest and hence more of them can be induced by expansionary monetary policy to make a large investment.
More generally, the evidence shows that heterogeneous investment behaviour between young and old firms does not necessarily reflect differences in access to financing, which constitutes another difference between young and old firms (Cloyne et al. 2023). The combination of lumpy investment behaviour and firm life cycles makes young firms more responsive to monetary policy even in the absence of financial frictions.
Lumpy investment makes of monetary policy particularly effective whenever many firms are inclined to invest
Finally, we study the implications of lumpy investment behaviour and the extensive margin investment channel for the effectiveness of monetary policy in stimulating aggregate investment.
With lumpy investment, there are at least three, potentially time-varying, economic conditions that matter for the effectiveness of monetary policy. First, in a cyclical boom, more firms are inclined to make an investment, which increases the effectiveness of monetary policy. Second, in times of high uncertainty, firms tend to delay investment decisions, rendering monetary policy ineffective (Bachmann and Bayer 2024). Third, when business dynamism is high and there are many young and growing firms, monetary policy is more effective.
We use a calibrated heterogeneous-firm model with lumpy investment and firm lifecycles to quantify by how much the decline in business dynamism observed in the US since the 1980s (Ates and Akcigit 2019) has weakened the effectiveness of monetary policy. Figure 3 shows that when there are many young firms (“high dynamism”), as in the 1980s, monetary policy is around 11.5% more effective in stimulating investment and increasing the stock of capital than when there are fewer young firms (“baseline”) and business dynamism is low, like today.
Figure 3 An expansionary monetary policy shock increases the aggregate capital stock more strongly in a more dynamic economy with more young firms
Source : VOXeu
