Introduction

In this chapter, we study the effects of monetary policy on Italian firms' investment. A broader analysis is in Gaiotti and Generale (2001, 2002).

The available evidence on the effect of monetary policy on investment in Italy is mostly at the macroeconomic level (Banca d'Italia, 1986), and it indicates that a 1 percentage point increase in the interest rate has a negative impact on non-residential investment of the order of 2–3 percentage points each year (Nicoletti Altimari et al., 1995).

At firm level, the empirical literature is extensive, but it only indirectly addresses the effects of monetary policy. The main result is that financial variables (notably, cash flow) affect investment, particularly for small firms (Bianco, 1997; Franzosi, 1999; Galeotti, Schiantarelli and Jaramillo, 1994; Rondi, Sembenelli and Zanetti, 1994; Schiantarelli and Sembenelli, 2000); this is consistent with the existence of a broad credit channel of monetary transmission. Rondi et al. (1998), using time-series data for large and small firms, also find that following a tightening episode, small firms report a steeper fall in sales. These results, however, at most give a qualitative hint of monetary policy's impact on different classes of firms.

The contribution of this chapter is to offer a more precise assessment of these effects. The improved precision comes from explicitly modelling the different channels through which monetary policy can affect investment and estimating the channels using panel data on firms' investment. One channel is through the user cost of capital.