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Keynes Fund


Summary of Project Plan

There has been an unprecedented growing trend in sustainable investing over the past decade. Today, sustainable strategies comprise one third of professionally managed U.S. assets (Pastor et al., 2020). Sustainable investing combines traditional investment approaches with environmental, social and governance (ESG) insights. Among the ESG criteria, environmental considerations seem to be playing a leading role: 88% of the clients of BlackRock, the world’s largest asset manager, rank environment as “the priority most in focus” (BlackRock, 2020). Such environmental awareness is reshaping the composition of firms in the economy. Engle et al. (2020) documents that a growing number of firms are altering their commercial focus to reduce emissions, both in the goods and services they directly produce and also throughout their supply chains. If nations are to achieve the Net Zero transition, then this trend will have to continue over coming decades.

This shift towards lower carbon emissions (and a reduced environmental impact more generally) entails firms investing in new and different types of technologies, up and down supply chains. This means that green firms may look different from their brown counterparts, in terms of their balance sheet characteristics and funding structures (Albuquerque et al., 2021). This has potentially important implications for the transmission mechanism of monetary policy. It is already understood that firm-level responses to monetary policy can be heterogeneous (e.g. Ottonello and Winberry, 2020; Cloyne et al., 2018; and Jeenas, 2019). Existing literature has studied this type of heterogeneity with regards to firm indebtedness, age, and liquidity. However, there is not yet any work on the impacts of the Net Zero transition on monetary policy transmission. We aim to fill this gap.

This project will contribute by exploring whether the investment channel of monetary policy affects firms differently depending on ``how green’’ they are. In other words, we will ask whether greener firms’ investment decisions are more or less responsive to monetary policy shocks than their ``browner’’ counterparts. Additionally, we will seek to explore whether this responsiveness is symmetric across episodes of tightening vs loosening. In addition, if there is any difference, we would like to understand the possible explaining factors.

It is ex-ante not obvious whether greener firms should respond differently from other firms. On the one hand, greener firms are younger (Demirel et al., 2017). Existing literature suggests that how young a firm is, is a good proxy for financial constraints (Fort et al., 2013). This literature also shows that tighter constraints make firms more responsive to monetary policy shocks (Cloyne et al., 2018). On the other hand, greener firms also rely relatively more on intangible assets (Forbes, 2020). Existing literature suggests greater use of intangibles makes firms less responsive to monetary policy shocks for two main reasons. First, they use less debt because intangibles are a poor source of collateral for lenders (e.g. Dottling and Ratnovski, 2020). Second, intangibles depreciate much more quickly than tangibles (e.g. Crouzet and Eberly, 2019). This means that a given change in interest rates causes a smaller change in the cost of capital that firms with relatively more intangibles face compared to those with more tangible assets.

Without a clear prediction from theory, our main goal is to address these questions empirically. This is not necessarily a trivial exercise. Our initial exploration has found that there are many providers of ESG scores, but that there appears to be little correlation of the scores among providers. Therefore, we will need to collect data from multiple providers, and undertake a substantial processing exercise to uncover a meaningful environmental score.

We intend to identify shocks to monetary policy, by using high-frequency movements in federal funds futures around Federal Open Markets Committee (FOMC) press releases. This allows us to isolate the unexpected component of monetary policy announcements. Our firm level data will be drawn from the universe of publicly listed firms available in the Center for Research in Security Prices (CRSP). Accounting data will be collected from Compustat Fundamentals Quarterly files. We will use environmental (E) scores extracted from the ESG databases provided by MSCI, Sustainalytics and RepRisk as measures of stocks’ environmental friendliness. To explore the underlying mechanism that might drive heterogenous responses to monetary policy (depending on firm “greenness”), we will consider explanatory variables, such as: book leverage, age, intangible asset ratios, firm size, and asset growth.

Our empirical strategy will borrow from Ottonello and Winberry (2020) and look at the capital accumulation response by firms to a contractionary monetary policy shock. We will also investigate an expansionary monetary policy shock but we will allow for asymmetric effects of monetary (positive and negative) shocks. This method controls for unobserved firm characteristics, as well as industry and time fixed effects. We believe that suitable ESG score data is available from at least 2009 and runs to the present. Our analysis will therefore consider the period after the Global Financial Crisis (GFC).

There has been little variation in conventional monetary policy in the post GFC period. However, we will nevertheless be able to identify the impact of monetary policy shocks. This is because existing literature has developed methods to measure unconventional monetary policy actions (e.g. Swanson, 2021; Rogers et al., 2018; Rogers and Wu, 2021). By employing these techniques, we will be able to extract a forward guidance and quantitative easing component from the changes in Federal Fund futures around FOMC announcements.

Overall, we will be able to estimate how firms respond to monetary policy shocks, and importantly how these responses depend on the firms’ environmental stances. This seeks to shed light on how the Net Zero transition might affect the transmission of monetary policy.



Professor Tiago Cavalcanti


Tiago Cavalcanti is a Professor at the Faculty of Economics, University of Cambridge and a Fellow of Trinity College. His most recent research has focused on links between financial development and economic development, and on the role of female labour force participation on economic development.


Kamiar Mohaddes


Dr. Kamiar Mohaddes is an Associate Professor in Economics & Policy at the Judge Business School at the University of Cambridge and a Fellow in Economics at King's College, Cambridge. His main areas of research are applied macroeconomics, global and national macroeconometric modelling, energy economics, and climate change.



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