European Central Bank working paper finds multiple firm financing constraints amplify the impact of rate hikes and mute the effect of rate cuts

The European Central Bank has published Working Paper No 3217 on how the credit channel of monetary policy changes when firms face multiple financing constraints. The paper develops and tests a mechanism in which the coexistence of several tight constraints makes monetary tightenings transmit more strongly into borrowing and investment than equally sized easings, offering an explanation for the commonly observed asymmetry in monetary policy effects. The authors model firms whose borrowing capacity is simultaneously limited by several occasionally binding constraints, implying that after a rate hike the most interest-rate-sensitive constraint becomes binding, while after a rate cut the least sensitive constraint remains binding. Using U.S. firm-level data (Compustat, 1990–2024) combined with syndicated loan covenant data (DealScan) and a distance-to-default measure, the analysis finds that firms with multiple tight constraints drive the asymmetry: their external financing and investment fall markedly more after contractionary shocks and respond little to accommodative shocks, while unconstrained firms respond more symmetrically. A quasi-natural experiment based on the ASC 842 lease-accounting change effective in 2019 is used to generate plausibly exogenous tightening of leverage-based covenants for high-lease firms, which is associated with a stronger post-change asymmetry in their responses. Embedding the mechanism in a calibrated New Keynesian framework, the paper reports that the cumulative investment drop after a contractionary shock is about twice as large as the increase after an equally sized expansionary shock.