Monetary policy and the financial decisions of firms

In this paper we develop a general equilibrium model with heterogeneous, long-lived firms where financial factors play an important role in their production and investment decisions. When the economy is hit by monetary shocks, the response of small and large firms differs substantially, with small firms responding more than big firms. As a result of the financial decisions of firms, monetary shocks have a persistent impact on output. Another finding of the paper is that monetary shocks lead to considerable volatility in stock market returns.