The sharp increase in U.S. policy rates post-pandemic had a muted effect on demand relative to historical experience. This paper argues that high and rising liquidity among nonfinancial corporations (NFC) weakens monetary policy transmission by insulating investment from external financing conditions. Firm-level local projections show that larger liquid-asset buffers dampen investment’s response to monetary tightening. However, as literature suggests, standard interaction-based estimates are confounded by the endogenous relationship between liquidity and firm characteristics such as size, leverage, and age. To address this, we adopt a granular instrumental variables (GIV) approach that exploits idiosyncratic variation in the cash holdings of large firms to identify exogenous changes in aggregate corporate liquidity, providing causal evidence that higher cash ratios cushion declines in aggregate investment. To examine the conditions under which cash buffers mitigate the contractionary effects of monetary tightening, the paper implements comparative statics and simulations on a stock–flow consistent (SFC) growth model where the investment is conditioned by NFC cash holdings. When firms hold large cash buffers, monetary tightening can have muted effects on demand and may reduce long-run investment and growth. These results imply that monetary policy is less effective in economies with high corporate liquidity, highlighting a novel channel linking corporate balance sheets to macroeconomic outcomes.
Keywords: Monetary Policy Transmission; Local Projections; Granular Instrument Variables; Corporate Finance; Stock–flow consistent model
JEL classification: C36 E12 E22 E52 G32
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