Monetary Policy Transmission in Australia1
Recent years have seen unprecedented monetary policy tightening across advanced economies, including Australia, to combat significant inflationary pressures. As the Reserve Bank of Australia (RBA) navigates the last mile of disinflation, Chapter 1 of the Special Issues Paper, Monetary Policy Transmission in Australia, examines monetary policy transmission via three lenses: (a) assessing how aggregate economic dynamics in the current monetary tightening cycle in Australia compare with experiences in other major advanced economies (AEs) and in previous RBA monetary tightening cycles; (b) highlighting recent evidence on the strength and speed of monetary policy transmission via the housing sector in Australia; and (c) assessing the strength and speed of monetary policy transmission via corporate balance sheets in Australia, including to capture differences from other AEs and to account for heterogeneity among firms and sectors. We find that while macroeconomic dynamics in Australia in the current tightening cycle have not differed significantly from historical experience and from experiences in other major AEs, the resilience of Australia’s economy in recent years is remarkable, as evidenced by persistently tight labor markets. Second, several features of the Australian housing market, most notably the high prevalence of variable rate mortgages, may strengthen monetary policy transmission to households relative to other AEs. Lastly, we find that firm investment in Australia’s non-extractive sector is strongly sensitive to monetary policy changes; the sensitivity is more pronounced for firms with less liquidity, higher leverage, and higher reliance on bank and short-term financing. We highlight how resilience in Australian corporate balance sheets in recent years may have helped soften monetary policy transmission to investment in the current cycle.
A. Is the Current Australia Monetary Tightening Cycle Different?
1. In this section, we examine the evolution of key macroeconomic indicators during the current monetary tightening cycle in Australia. In particular, we assess whether the economic dynamics signal transmission may differ from previous tightening cycles or from experiences in other major AEs in the contemporary tightening cycle. We consider select indicators of prices, national accounts, and labor markets for this purpose.
Comparison with Previous Australia Tightening Cycles
Australia: Monetary Tightening Cycles
Australia: Monetary Tightening Cycles
| Cycle* | Duration (months) | Total Rate Increases | # of Rate Hikes | Peak inflation** |
|---|---|---|---|---|
| Aug-1994 to Jun-1996 | 23 | 2.75 ppt | 3 | 5.1 |
| Nov-1999 to Jan-2001 | 15 | 1.50 ppt | 5 | 6.1 |
| May-2006 to Aug-2008 | 27 | 1.75 ppt | 7 | 5.0 |
| Oct-2009 to Oct-2011 | 25 | 1.75 ppt | 7 | 3.5 |
| May-2022 to present*** | 29 | 4.25 ppt | 13 | 7.8 |
Australia: Monetary Tightening Cycles
| Cycle* | Duration (months) | Total Rate Increases | # of Rate Hikes | Peak inflation** |
|---|---|---|---|---|
| Aug-1994 to Jun-1996 | 23 | 2.75 ppt | 3 | 5.1 |
| Nov-1999 to Jan-2001 | 15 | 1.50 ppt | 5 | 6.1 |
| May-2006 to Aug-2008 | 27 | 1.75 ppt | 7 | 5.0 |
| Oct-2009 to Oct-2011 | 25 | 1.75 ppt | 7 | 3.5 |
| May-2022 to present*** | 29 | 4.25 ppt | 13 | 7.8 |
2. The current episode marks the RBA’s most aggressive monetary tightening cycle. We identify four previous (pre-pandemic) monetary tightening cycles, where the RBA raised rates two or more times in a row, as summarized in Table 1.2 In the current tightening cycle, the RBA raised interest rates 13 times from May 2022 to November 2023, for a total increase of 4.25 percentage points in the cash rate. This marks by far the largest cumulative rate increase and highest number of hikes of any tightening cycle in Australia; prior to the pandemic, the largest cumulative rate increase in a single cycle had been just 2.75 percentage points, and the maximum number of rate hikes per cycle only seven (Table 1). The scale of the tightening was commensurate with the unprecedented size of the inflation shock, helping to bring down inflation from a peak of 7.8 percent in 2022Q4, to faster pace of disinflation than witnessed in any previous cycle. Despite the large cumulative tightening, real rates were not as restrictive as previous cycles; given elevated inflation (and high one-year-ahead inflation expectations), real rates were actually negative for the first year of the current cycle. While the change in the cash rate was of a large scale, the level reflected the need for restrictive policies to bring inflation back to target while aiming to preserve as much of the gains in the labor market as possible (weighing the RBA’s dual mandate). Medium-term (market-implied 2-year ahead) inflation expectations remained well anchored throughout the cycle.
Policy Rates and Inflation
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
3. Macroeconomic dynamics in the current monetary tightening cycle in Australia have been broadly similar to those in past cycles, once accounting for the larger scale of policy rate hikes. Economic growth has been soft-for-longer relative to previous cycles (Figure 2), consistent with the deeper and longer monetary tightening in this cycle; in fact, given the unprecedented scale of current tightening, the fairly narrow gap in growth with past cycles may be interpreted to signal resilience. While growth in public demand has been strong in the current cycle, it has not been stronger than in past cycles. On a per capita basis, the impact on consumption – while showing up with a lag – has been more protracted and severe than in the past; per capita consumption growth fell into negative territory in the latter part of the current cycle (unprecedented in previous cycles). The delay in the reaction of consumption relative to previous monetary tightening cycles may be linked to changes in the maturity of mortgages (see Section B). Weak consumption this cycle has been consistent with weak real income growth. The reaction of private investment in the current cycle also appears delayed relative to previous cycles – with investment contracting in the last two quarters, following moderate growth. In previous cycles, private investment had slowed immediately as the monetary tightening began, before picking up in the latter part of the cycle.
Evolution of Macroeconomic Variables
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
4. The labor market has been notably tighter than during previous monetary tightening cycles, while the financial sector has remained resilient. Labor market tightness early in the current cycle can be partly attributed to the curtailment of immigration during the pandemic, which exacerbated demand supply imbalances; this source of imbalances eased gradually with the return of migrants. As migrants returned and the impact of monetary policy transmitted through the economy during the current cycle, unemployment rates have been adjusting up slowly from record lows, but still remain below those observed in previous monetary tightening cycles. It is worth noting that past monetary tightening cycles in Australia have not seen significant adjustment up in unemployment. This may reflect the RBA’s dual mandate, which weighed the need for restrictive policies to bring inflation back to target with the aim to preserve as much of the gains in the labor market as possible. Despite the tight labor market, real wage growth has been negative for much of the current cycle, as wage rises failed to keep up with significant price pressures – contrasting experiences in most previous tightening episodes. This puzzle may be in part explained by conjunctural factors, such as the transitory nature of supply side shocks driving some of the recent inflation, softening productivity, or structural factors, such as changes in collective bargaining in recent decades.3 House prices – coming off a period of exceptionally rapid growth – have cooled more and faster during this monetary tightening cycle than in previous cycles, but have then picked up again, with post-pandemic gains preserved. Bank lending in the current cycle has continued to expand, broadly in line with trends in previous cycles.
Labor Market and Financial Indicators
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Comparison with Other Major Advanced Economies in the Contemporary Cycle
5. In the current tightening cycle, both inflation and the scale of policy rate hikes have been relatively contained in Australia compared to other major AEs. Most AEs faced unprecedented inflation post-pandemic, with central banks raising policy rates in response. Inflation in Australia peaked at the lower end of the scale when compared to peers (peak inflation was only lower in New Zealand); in turn, maximum cumulative policy rate hikes were also lower than for most peers (except Sweden). Australia has also seen a slower pace of disinflation than other AEs. While the RBA is one of the last central banks to cut rates among peers (along with the Norges Bank), this also reflects a later peak in inflation and a subsequent later tightening of rates than in some peers. At first glance, there is no clear correlation between the scale of the rate hikes and the pace of disinflation among AEs, the EA and Sweden. The evolution of real interest rates in Australia during the current tightening cycle has been broadly similar to that in peers. The price pressures seen in Australia’s rental markets are not unique, with rent inflation also elevated in Canada, the UK, and the US, and similarly persistent in the former two.
Policy Rates and Inflation in Advanced Economies
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
6. Australia’s economy has been more resilient than peers during the current monetary tightening cycle.
Consistent with more moderate policy rate hikes, the growth slowdown in Australia has been softer than in AE peers undergoing a similar cycle (except the US, which has seen similarly robust growth amid deeper tightening). The evolution of per capita consumption in Australia has been in line with peers, but investment has been much stronger – reflecting in part the surge in public investment. Despite robust public demand supporting growth, Australia was one of the only AEs experiencing fiscal surpluses during the current tightening cycle, reflecting strength in revenues linked to commodity prices.
Labor markets have also been more resilient in Australia, even as labor market tightness has been a near-universal experience in recent years for peer AEs. In most peers, unemployment fell near record lows and vacancies rose sharply after economic reopening, with the latter coming down only gradually (see Staff Report Annex V). Unlike in peer economies, however, where unemployment has broadly returned to pre-pandemic levels after one-two years of monetary tightening, labor markets in Australia remain tight by historical standards, with unemployment still well below pre-pandemic levels. This likely reflects, at least in part, the RBA’s efforts to set policy rates which, while sufficiently restrictive to bring inflation back to target, also helped preserved as much of the gains in the labor market as possible.
Growth and Unemployment in Advanced Economies
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Source: Haver Analytics and IMF staff calculationsB. Transmission via the Housing Channel
7. Australian households are strongly susceptible to the impact of changes in policy rates due to features of the housing market. Rising policy rates increase interest expenses on mortgages, in turn reducing consumption. Recent empirical analyses confirm that the strength of this transmission channel varies depending on the frequency of mortgage interest rate resets
with higher reliance on variable rate mortgages strengthening transition (April 2024 World Economic Outlook, Chapter 2). Other factors that strengthen transmission via this channel include the absence of loan-to-value (LTV) limits, which result in more leveraged buyers, high household debt, housing supply constraints, and overvaluation.4 These factors also reinforce each other to further strengthen the impact on consumers. Thus, the transmission of monetary policy via the housing channel has been found to be stronger in Australia than in other peer advanced economies, due to high reliance on variable rates, high household debt, low LTV ratios, and a higher share of the population living in supply-constrained areas. This channel only applies, however, to mortgage holders, which account for around 40 percent of Australian households.
Heterogeneity in Monetary Policy Transmission to Households
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Source: IMF World Economic Outlook, April 2024.8. Transmission to household consumption in Australia may be amplified by incentives to save against mortgage costs. As policy rates have risen, interest costs in Australia have been taking up a larger share of disposable income, from 4.8 at end-2022 to 6.5 percent in 2024Q1 (Figure 7). At the same time, rising policy rates are creating incentives for early repayments in order to reduce debt service costs for borrowers holding variable rate mortgages; the share of early repayments has also risen as a share of real household disposable income from 1.5 to 2.3 percent over the same period. Mortgage offset and redraw accounts – both of which allow mortgage holders to save against their loans and interest costs, while still preserving access to the savings – are not common outside Australia, but becoming increasingly popular within Australia. These products, which offer a de facto interest rate equal to the mortgage interest rate, which (for households where rates reset frequently) is higher than interest rates that can be obtained through savings, raise incentives to save and may further reduce consumption for the marginal household. Currently, around 48 percent of mortgage accounts in Australia have associated offset accounts, and 74 percent have redraw accounts.
9. Monetary policy transmission in Australia via the housing channel may have softened slightly in the current cycle due to a higher share of fixed-rate mortgages. RBA analysis shows that pass-through from cash rates to the average outstanding mortgage rate has been slightly slower than in previous tightening episodes; they attribute this to a larger share of the loans outstanding at the start of the pandemic having with a two-year or longer fixed-rate component.5 The higher share of fixed-rate mortgages may partly explain the delay in the reaction of per capita consumption to monetary policy in this cycle relative to previous tightening cycles, identified in section A. However, the often short maturity of the fixed-rate element in these loans, combined with the still high policy rate, suggests pass-through to households could continue.
Mortgage Rates and Repayments
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Sources: Haver Analytics and IMF staff calculations.C. Transmission via Corporate Balance Sheets
10. Another important channel in the transmission of monetary policy to the real economy is via corporate balance sheets and investment. In recent decades, a growing body of economic literature has investigated how corporate investment responds to monetary policy, and how this response differs by sector or by firm characteristics. However, fewer analyses have investigated this transmission channel in Australia, potentially due to the large footprint of the mining sector, whose lumpy investment is driven by external factors and might mask developments in other sectors. In this section, we seek to understand (i) how firms adjust their investment in response to monetary policy; (iii) how monetary policy fluctuations affect firm earnings; and (iii) whether the transmission differs across firms with different balance sheet characteristics. As we explore these topics, we also assess whether and how transmission differs in Australia compared to other AEs, and ascertain implications for Australia’s economy going forward.
11. Economic literature has proposed several mechanisms via which monetary policy can affect corporate investment, with implications for the heterogeneity of transmission across firms and sectors. One is the interest rate channel, where monetary tightening raises real rates and consequently decreases consumer and firm demand for durable goods or investment. Another is the credit channel, whereby due to financial frictions in credit markets, monetary tightening leads to an external financing premium which impacts borrowing and investment (Bernanke and Gertler, 1989; Bernanke et al., 1999). The interest rate channel is most relevant for firms in sectors where consumer demand is most sensitive to interest rates – such as durable goods producers. The credit channel primarily impacts firms with financial constraints, which have been proxied in recent literature through various balance sheet characteristics (e.g., size, leverage, liquidity, and debt composition). Studies on firms in the US, UK, and Europe have found evidence of heterogeneity in the impact of monetary policy on firm investment consistent with the presence of both channels – including findings that smaller firm, younger firms, those with more leverage, less liquidity, or more reliance on short-term or bank debt, but also those in the durable goods sectors, see investment respond more strongly to monetary policy.6
12. In Australia, the importance of the corporate balance sheet channel has been subject to debate. The large footprint of the extractive sector, where investment is lumpy and driven by external factors and actors, may obfuscate to an extent the effect of domestic monetary policy on investment. In addition, some have argued that sticky hurdle rates render investment less sensitive to monetary policy transmission, with firms effectively ‘looking through’ the business cycle (Edwards & Lane, 2021; Lane and Rosewall, 2015).7 On the other hand, Hambur and La Cava (2018) look at firm-level data in Australia and find a significant inverse relationship between the cost of debt and corporate investment not evident in aggregate data. More recently, Nolan et al (2023) have used administrative data to document that investment in the non-mining sector does respond to monetary policy shocks, both at the intensive and extensive margin; they find the response peaks after around two years, and is broadly similar across firms of different age and sizes, contradicting the hypothesis that some, especially larger, firms do not respond to monetary policy due to sticky hurdle rates. The authors also find tentative evidence of financial frictions, with the investment of firms in sectors more reliant on external financing and of firms that report financial constraints more responsive to monetary policy shocks. Majeed and Breunig (2023) also document that monetary policy can affect innovation (R&D spending, trademarks) in Australia, especially for small firms.
Empirical Analysis of the Transmission of Monetary Policy to Corporate Investment
13. To shed further light on the corporate balance sheet channel of transmission in Australia, we develop an empirical framework to assess the reaction of corporate balance sheets to monetary policy shocks. We first consider how firm earnings react to monetary policy shocks, which can inter alia indicate the extent to which firms pass through the cost of tightening to consumers. We also consider whether earnings across different firms react differently. Next, we consider the scale and timing of the reaction of corporate investment to monetary policy shocks. Finally, we assess which firm characteristics affect transmission to investment. In Annex II, we also consider the pass-through of monetary policy to effective interest rates for firms. Throughout these analyses, we consider how the scale and timing of transmission differs in Australia compared to in peer AEs.
14. Data and methodology. The data and empirical specifications are described in more detail in Annex I. In brief:
For this analysis, we use a panel of firm-level balance data from across 22 AEs covering 2001Q1 to 2023 Q1. The data is sourced from Capital IQ.
Our methodology relies on a local projections framework and uses monetary policy shocks identified by Deb et al (2023), which are orthogonal to other macroeconomic developments, to limit reverse causality and omitted variable bias. A positive (negative) monetary policy shock indicates policy tightening (loosening); for Australia, shocks are available from 2001Q1 to 2022Q4. The impulse response functions generated illustrate how variables of interest evolve after a monetary policy shock.
To assess heterogeneity across firms in the strength and timing of monetary policy transmission, we divide firms into two groups for each variable of interest: firms that are, on average, above vs. those that are, on average, below the median sector value for that variable. We consider leverage, liquidity, debt composition, size, asset tangibility, and age as variables of interest. We then use a dummy variable to separate these two groups, and interact it with the monetary policy shock. The coefficients of this interaction term show the differential impact of monetary policy on firms with higher values of the variable of interest versus those with lower values.
15. The earnings of Australian firms appear more sensitive to monetary policy than the earnings of firms in other AEs. In line with expectations, earnings decline (increase) after a tightening (loosening) monetary policy shock. In other AEs, the impact lasts for about two years, and peaks around one year after the shock; at peak, a 100 basis point shock generate a five percent change in real earnings. In Australia, the impact of monetary policy shocks on earnings is not significant when all sectors are considered; however, when limiting the analysis to non-extractive sectors, the impact on earnings is strong and significant. The impact on earnings in Australia’s non-extractive sector starts and peaks around one quarter later than in other AEs. At peak, earnings change by 40 percent following a 100 bps policy shock.8 This higher sensitivity suggests Australian firms are either facing stronger adjustments in demand after policy shocks (consistent with the strong pass-through to household consumption via the housing sector, discussed in section B), or that they are less able to adjust prices to pass on the costs (benefits) of monetary tightening (loosening) to consumers.
Evolution of Firm Earnings after a Monetary Policy Shock
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Sources: Capital IQ and IMF staff calculations.16. We find some evidence that the sensitivity of firm earnings to monetary policy differs across firms with different characteristics. A more positive reaction of earnings to policy shocks for a subset of firms signals a weaker transmission for these firms (e.g., earnings decline by less in a monetary tightening). In other AEs, firms with more tangible assets see a stronger impact of monetary policy on their earnings; this may reflect the stronger impact of the interest rate channel on durable goods sectors, which are also highly reliant on tangible capital. We find no evidence of this pattern in Australia’s non-extractive sectors. However, we do find some evidence that the earnings of older firms in Australia’s non-extractive sectors are more sensitive to monetary policy than those of younger firms, which contradicts potential priors that older firms have more established consumer bases and thus face less elastic demand.
17. We find evidence that corporate investment is sensitive to monetary policy, including for firms in the non-extractive sector in Australia. Investment reacts slowly: in other AEs, the impact on investment peaks almost two years after the initial policy shock, when a 100 basis point tightening (loosening) monetary policy shock is associated with a 5 percent decline (increase) in real investment. In Australia, while results are not significant when including the extractive sector, there is evidence that investment is sensitive to monetary policy shocks in the non-extractive sector. Investment reacts with a lag in this sector in Australia relative to trends in other AEs, but the reaction is more persistent; at its peak (which occurs around 2–3 years after the policy shock) the impact is much larger than for other AEs, with a 100 basis point monetary policy tightening (loosening) shock translating to a 20 percent decline (increase) in investment. This is consistent with the stronger reaction of earnings to monetary policy shocks in Australia’s non-extractive sector, documented above.
Evolution of Investment after a Monetary Policy Shock
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Sources: Capital IQ and IMF staff calculations.18. We also find the sensitivity of firm investment to monetary policy shocks varies with balance sheet characteristics that may be considered proxies for financial constraints. For any subset of firms, a more positive reaction of investment to policy shocks than in other firms signals weaker transmission (e.g., investment declines by less in a monetary tightening, or increases by more during a monetary loosening).
Heterogeneity in the Evolution of Investment after a Monetary Policy Shock
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Sources: Capital IQ and IMF staff calculations.Across advanced economies, the investment of larger firms and of firms with more liquid assets is found to be less sensitive to monetary policy shocks; for the former, the differential impact manifests in the first two years after a policy shock, while for the latter, it is only significant around three years after the shock. The smaller sensitivity of investment to monetary policy for larger firms in Australia and in other AEs is not surprising, as these firms often have greater availability of internal finance;9 however, it raises the question of whether growing market concentration may be reducing the strength of monetary policy transmission globally.
Within Australia’s non-extractive sector, we also find evidence that the sensitivity of firm investment to monetary policy is higher for firms with higher leverage, and for firms with more reliance on bank-funded or short-term debt. The differential impact by leverage is significant two to three years after a policy shock. The higher sensitivity of investment to monetary policy shocks for firms more reliant on bank debt is consistent with findings in economic literature that bank lending rates are more responsive to monetary policy than corporate bond market rates. The higher sensitivity of investment to monetary policy for firms with more short-term debt is unsurprising given these firms are more exposed to shifting financial conditions as they roll over debt more frequently. While the differences in the response of investment between firm groups identified in this exercise are in some cases fairly small in scale, the difference in the response of investment between firms at the bottom and top ends of the distribution may be much larger.
Implications for the Current Tightening Cycle
19. Firm earnings and investment have declined during the current tightening cycle. In Australia, the median firm has seen a decline in real pre-interest pre-tax corporate earnings (EBIT) of around eight percent in 2023; in other AEs, the decline has been larger, potentially reflecting the larger scale of the tightening (as elaborated in Section A).10 The decline in EBIT signals that firms have not been able to fully pass through the impact of high inflation and lower demand to consumers. At the same time, firms have also decreased investment; capex spending for the median firm declined in real terms across AEs, including in Australia in 2023 (in the latter, by around five percent).
20. The current tightening has raised corporate debt servicing costs, although the net effect has been partially mitigated by rising interest earnings. Higher interest rates have translated into higher effective interest rates paid by firms across AEs, with effective interest rates paid by Australian firms rising by almost 1.5 percentage points in 2023.11 At the same time effective interest rates earned by Australian corporates on their liquid assets rose by around the same amount, with even stronger increases in other AEs undergoing monetary tightening. This increase in earned interest rates, together with substantial cash holdings, has helped mitigate the impact of higher paid interest rates on balance sheets, reducing the increase in net effective interest rates; net effective interest rates only increased by around half a percentage point in Australia in 2023. A similar pattern is observable for Australian households, where interest receivable also increased during the recent tightening cycle, softening the rise in net interest income.
Corporate Balance Sheets in the Current Tightening Cycle
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Sources: Capital IQ and IMF staff calculations.21. The high cash holdings of Australian corporates may be softening the transmission of monetary policy to investment. At the start of the tightening cycle, Australian firms had significant cash buffers relative to most other advanced economies. Based on the results of our empirical may have helped partly mitigate the impact of monetary tightening on investment. With higher cash holdings relative to 25 years ago, Australian firms are also likely to be more resilient than they were during the 1999 tightening cycle. Cash holdings at the start of the current tightening cycle were, however, uneven across sectors; lower cash holdings in the consumer goods and industrial sectors may make investment in these sectors more vulnerable in the current context.
Cash Holdings
(Percent of assets, median firm)
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Source: IMF analysis of Capital IQ data.22. Shifts in leverage and debt composition may have also rendered Australian corporate investment less sensitive to monetary policy in this tightening cycle relative to previous cycles. Empirical results suggest investment to be more sensitive to monetary policy for more leveraged firms, and for firms with more reliance on bank and short-term debt. At the start of the current tightening cycle, the median firm in most sectors in Australia was less leveraged than in the past. The share of bank debt has also decreased significantly over the last two decades across most sectors, likely rendering investment less vulnerable to monetary policy overall. Differences in financing across sectors also suggest differences in sensitivity to monetary policy. At the start of the current cycle, leverage was more elevated in the consumer goods, industrial, and communication sectors, signaling the potential for more volatile investment. While short-term and bank debt remain elevated in the material and energy sectors, these are less likely to be impacted by monetary policy overall, as discussed above.
23. While stronger balance sheets may have so far softened the impact of monetary policy on corporate investment, caution is warranted given transmission lags. The relative balance sheet resilience of Australian firms, both compared to peers and compared to previous decades, may indicate a softer transmission. This resilience may ease financial frictions and continue to allow firms to limit cyclical adjustments to investment. However, going forward, caution is warranted, as Australia has seen long lags in the transmission of monetary policy to investment, suggesting further downturns in investment as a result of the current tightening cycle are possible.
Balance Sheet Characteristics at the Start of the Current Cycle
Citation: IMF Staff Country Reports 2024, 361; 10.5089/9798400297885.002.A001
Sources: Capital IQ and IMF staff calculations.D. Conclusions
24. We find macroeconomic dynamics in Australia in the current monetary tightening cycle to be broadly consistent with experiences in peer AEs and in previous RBA tightening cycles, while taking note of the remarkable resilience of the Australian economy in recent years. After accounting for the larger scale of inflation and commensurate policy rate hikes, the dynamics of Australia’s economy in the current cycle have not differed substantially from dynamics in past tightening cycles, beyond some evidence of lags in transmission to both household consumption and private investment. While it has experienced slightly slower disinflation than many peers in the current tightening cycle, Australia has also benefitted from more economic resilience than most other AEs, as reflected both in a moderate growth slowdown and persistent tightness in labor markets; this may in part be attributed to prudent monetary and fiscal policies, the former supported by the RBA’s dual mandate.
25. Recent literature finds monetary policy transmission via the housing sector is strong in Australia, due in part to the prevalence of variable rate mortgages. However, during the current cycle, the higher prevalence of mortgages with a fixed-term component may have helped delay or soften transmission via this channel. Constrained housing supply, high household debt, and no LTV limits, as well as the popularity of offset and redraw accounts which increase savings incentives, may amplify transmission to consumption via this channel.
26. We find evidence of strong monetary policy transmission via corporate balance sheets in Australia’s non-extractive sectors. We show both earnings and, more critically, investment in this sector are sensitive to monetary policy shocks – potentially more sensitive than in other AEs. We also find that the sensitivity of investment to monetary policy in Australia’s non-extractive sector varies across firms depending on their size, cash holdings, leverage, and debt composition. As such, the more resilient balance sheets of Australian corporates at the start of the current tightening cycle may have softened transmission via this channel in the last two years.
27. There are several questions raised by the analysis above that, while outside the scope of this paper, could be of interest in further research. This includes (i) better understanding the drivers of the slightly delayed transmission to household consumption and corporate investment in Australia; (ii) assessing whether structural factors explain some of the cross-country heterogeneity in monetary policy transmission via corporate balance sheets (iii) considering interactions in the drivers of heterogeneity in transmission of monetary policy across firms;12 (iv) in the context of increased market concentration across economies and sectors, assessing how market structure plays a role in monetary policy transmission.
Annex I. Data and Methodology
1. The empirical analysis in Section C relies on a panel of quarterly firm-level balance sheet data from Capital IQ. This dataset, frequently used in the literature on monetary policy transmission to corporates, includes publicly listed non-financial corporates—firms that are larger and more systemic, contributing more to national account aggregates, but that may not be representative of small and medium enterprise experiences. To the extent financial constraints are tighter for private firms than for publicly listed firms, our findings might represent a lower bound for the role of financial frictions in the transmission of monetary policy to corporates. Quarterly data is better suited to identify reactions to monetary policy shocks. The data covers 22 advanced economies from 2001Q1–2023Q4, over broad range of sectors. We follow Kim (2019) and Kim et al. (2020) to clean the data. The resulting panel is highly unbalanced, with varied coverage for different firm characteristics. We omit the US from the sample, as US firms appear to respond differently (in earnings and investment) to monetary policy shocks compared to firms in other AEs, likely due to deeper capital markets and different financing alternatives, but are also significantly more abundant in the dataset and could bias the results.
2. We use a local projection method following Jordà (2005) to generate impulse response functions to assess the reaction of investment and other variables of interest to monetary policy shocks. We estimate the regression:
for different horizons k, where yn,c,s,t is variable of interest for firm n in country c and sector s at time t over the next k quarters (adjusted for inflation as relevant); MP shockct are monetary policy shocks; Xn,c,s,t-j are other control variables and
3. To identify how the transmission of monetary policy to variables of interest differs for firms with different balance sheet characteristics, we estimate the following regression, using local projection methods following Jordà (2005), to generate impulse response functions :
for different horizons k, where, for any firm characteristic, φns is an indicator variable that takes on the value of 1 if the firm has, on average, a higher-than-sectoral-median value of that firm characteristic, and 0 otherwise. Figure 8 and Figure 10 plot βk, the differential impact for firms with φ(n,s) = 1 vs. φ(n,s) = 0.
4. For this analysis, we use monetary policy shock derived in Deb et al. (2023). They authors identify monetary policy shocks in two steps. First, they calculate forecast errors in short-term rates by subtracting interest rates forecasts from realized interest rates. Next, they extract the part of these forecast errors that is orthogonal to the state of the economy by regressing the forecast errors on changes and forecasts of growth and inflation, as well as other pre-determined macroeconomic variables. They show the monetary policy shock series obtained in this manner are highly correlated with the shocks generated for the U.S. (Romer and Romer 2004) and the U.K. (Cloyne and Hurtgen 2016) following a similar approach. Since these shocks are exogenous to the macroeconomic environment, there is no need to include further macro controls.
5. Variables of interest are defined consistently with the literature. Investment is measured as capital expenditures (in log terms), adjusted for inflation. EBIT – earnings before interest and taxes – are also adjusted for inflation and used to measure earnings, and taken in log form. Tangibility is measured by the share of net plant, property, and equipment in the total capital stock. Effective interest costs are defined as interest (gross paid, earned, or net), divided by the previous period’s debt or liquid asset holdings, respectively. We also use information on leverage (total debt to total assets), short term debt (as a share of total debt), bank debt (as a share of total debt), size (assets as a share of GDP), and age (years since incorporation), based on information reported in Capital IQ.
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Prepared by Monica Petrescu.
Tightening in 2002 and 2003 is excluded as it reflected a normalization from an expansionary policy (see Nov 2003 Statement), and was not followed by rate cuts.
Despite the absence of LTV limits, other policy measures might not directly target LTV but achieve the same end (e.g., appropriately calibrated risk weights linked to LTVs, combined with Australia’s serviceability buffers).
Consistent with the presence of financial frictions, several studies find investment is more sensitive to monetary policy for firms with higher leverage (Jeenas, 2023; Ottonello and Winberry, 2020), firms more reliant on bank loans (Alder et al, 2023; Crouzet, 2021), or on floating rate or shorter term debt (Holm-Hadulla and Thurwachter, 2021; Gurkaynak et al, 2022; Ippolito et al, 2018), firms in industries with assets more difficult to collateralize (Choi et al., 2023) and firms with lower liquid assets holdings (Jeenas, 2023). Other proxies for the external financing premium that have been shown to impact the transmission of monetary tightening to investment include size (Gertler and Gilchrist, 1994) and age (Cloyne et al, 2023, among others). Investment and output in durable goods sectors has also been found to be more affected by monetary policy relative to other sectors (Choi et al., 2023; Durante et al, 2022; Dedola and Lippi, 2005). Financing frictions
This is consistent with findings by Sharpe and Suarez (2013) that some US firms do not actively respond to fluctuations in corporate debt rates, especially those with abundant cash reserves and no near-term plans to borrow.
This is unsurprising as earnings in the extractive sector are unlikely to respond to domestic factors, given they are primarily driven by global commodity prices and demand.
Foda et al. (2024) confirm that among older firms, size is a strong predictor of the likelihood of facing financial constraints, but this is not the case for younger firms.
The unusually large decline in Korea partly reflects the global downturn in the technology cycle.
Effective paid interest rates capture interest cost divided by the previous period’s debt. Effective earned interest rates capture interest earnings divided by the previous period’s holding of cash and cash equivalent assets. Net effective interest rates capture interest paid net interest earned, divided by the previous period’s debt.
For example, assessing whether the differential impact of policy shocks on investment for high vs. low cash firms differs depending on whether these firms are highly leveraged or not.
