Market Power, Financial Constraints, and Monetary Transmission

This paper explores the role of financial constraints in shaping the impact of firms’ markups on the responsiveness of their output to monetary policy shocks. We first develop a partial equilibrium model that highlights a key interaction between markups and the tightness of financial constraints: compared to unconstrained firms, constrained firms are more responsive to shifts in interest rates, but constrained low-markup ones are disproportionately more responsive. We then take this prediction to the data. Using a large cross-country firm-level panel dataset for 14 advanced economies, we find that young firms—which have been widely documented to be more credit constrained than older ones— are more responsive to monetary policy shocks than other firms are when they also have low markups