Staff Working Paper No. 1,093
By Thiago Ferreira and Daniel Ostry
We examine how the transmission of monetary policy to firm-level investment depends on firms’ financial conditions, as measured by their excess bond premia (EBPs), the risk premium component of their credit spreads. We first show that firm-specific EBPs compensate investors for the cyclicality of firms’ default risk, with lower-EBP firms’ default risk covarying less with aggregate risk. Next, we find that monetary policy easing shocks compress credit spreads more for higher-EBP firms, whereas lower-EBP firms increase their investment by more. Firms’ responses to credit supply shocks display the same pattern of heterogeneity. We rationalise these price and quantity responses with a model in which firms’ EBPs arise endogenously from the combination of firm-specific default-risk cyclicalities and aggregate financial intermediary balance sheet constraints. From micro to macro, we show that the cross-sectional distribution of firms’ EBPs shapes the aggregate potency of monetary policy.
This version was updated in February 2026.
Firm risk premia and monetary policy transmission