EXTERNAL FINANCE AND MONETARY TRANSMISSION MECHANISM IN UK

Cihan YALÇIN (University of Nottingham)

I incorporated a positive market interest rate as a measure of monetary stance into principal-agent theoretical framework allowing me to evaluate the impact of monetary policy on the firms` choice between intermediate and market finance and eventually on their investment. The model supports the evidence that small and poorly capitalised firms that have a few collateral assets and high risk are more likely subject to financial constraints under a tight monetary policy. I tested hypotheses derived from the model by using balance sheet data for almost 16 thousands UK manufacturing firms covering over the period 1990-1999. By employing panel data techniques, I found that firm heterogeneity such as; size, age, scores play a crucial role in the monetary transmission mechanism supporting the idea forwarded by Gertler and Gilchrist (1994). Evidence shows that small, young and low rating score firms have difficulties in accessing debt finance on which they depend more in contractionary phases. This result confirms the fact that small and financially weak firms are more likely subject to failure or reduction in their activity under the tight monetary policy.