Monetary Policy and Firm Trade Credit: Do Macroeconomic Indicators Matter?

Abstract

This paper investigates the presence of the credit channel using firm-level panel data of 450 firms listed at the Pakistan Stock Exchange from 1988-2021. Moreover, it uses a two-step system generalized method of moments (S-GMM) estimator to extend the market power theory and Meltzer's firm trade credit (FTC) theory by integrating the moderating role of financialization (FLN) and gross domestic product (GDP) growth in establishing the effect of monetary policy (MP) on FTC. Specifically, our analytical framework enables us to estimate the marginal effect of monetary policy (MP) on FTC at different GDP levels by considering different fixed levels of MP instruments. The results reveal a positive effect of MP on FTC, confirming the credit channel of monetary transmission mechanism (MTM). The results reveal that higher FLN facilitates firms to avail external borrowing during contractionary MP, which decreases MP's positive effect on FTC. The findings show that 1% increase in GDP will reduce the negative effect of MP on FTC by 0.0004% and it is significant at 1%. Similarly, 1% increase in FLN increases the negative effect of MP on FTC by -0.0002.

Moreover, the findings show that GDP growth strengthens the impact of monetary policy on firm trade credit. The empirical results give important policy implications. For example, FLN should increase competition among financial sectors to ensure the availability of funds and firms' investment efficiency at the time of contractionary MP. Moreover, the government should enhance GDP growth through tax exceptions so that firms should not suffer during tight MP periods.