RDP 2023-09: Does Monetary Policy Affect Non-mining Business Investment in Australia? Evidence from BLADE 6. Conclusion

Investment is a crucial driver of economic growth, both in cyclical and structural terms. As such, it is important to understand the extent that monetary policy affects business investment, as well as the channels through which this occurs, as it helps to inform policy, and helps us to understand how the effects of monetary policy could change over time. This is particularly relevant in the context of the surprisingly low levels of non-mining investment evident in Australia over the past decade.

Using exogenous monetary policy shocks and firm-level data we find evidence that monetary policy has a large effect on investment, both on the intensive and extensive margins. We find that contractionary monetary policy decreases both the likelihood that firms invest (extensive margin), and the extent of investment (intensive margin). The effects appear similar across firm age groups, suggesting that the aging of the firm population that has occurred due to declining firm entry rates should not have weakened the effect of monetary policy on investment. The effects are also similar across firm sizes. This suggests evidence that some, particularly larger, firms have sticky hurdle rates should not be taken to indicate that they do not respond to monetary policy.

That said, we do find some tentative evidence that the investment of the largest firms in each industry (‘leaders’) tend to be, if anything, less responsive to monetary policy. This is in contrast to US findings, and suggests that expansionary monetary policy over the past decade is unlikely to have contributed to the weakening in competitive pressures documented in other work (e.g. Hambur 2023).

Moreover, consistent with much of the literature, we find tentative evidence that financial frictions, such as collateral and cash flow constraints, may play an important role in the transmission of monetary policy, given the effect appears larger in sectors that are more exposed to external debt finance and for firms that claim to be constrained. This suggests that monetary policy may be particularly effective in times where these constraints are more binding, such as banking crises or downturns more generally.

Finally, we find evidence that monetary policy also affects investment expectations. However, monetary policy affects actual investment with a lag, and expectations of investment do not anticipate this response. In other words, instead of changing in advance of actual investment as might be expected, expectations move contemporaneously with actual investment. This suggests that reported expectations are somewhat reactive rather than being forward looking, and that forecasts based on these expectations may be slow to capture the effects of policy.