Monetary policy, business cycles, and the behavior of small manufacturing firms

We analyze the response of small versus large manufacturing firms to monetary policy. The goal is to obtain evidence on the importance of financial propagation mechanisms for aggregate activity. We find that small firms account for a significantly disproportionate share of the manufacturing decline that follows tightening of monetary policy. They play a surprisingly prominent role in the slowdown of inventory demand. Large firms initially borrow to accumulate inventories. After a brief period, small firms quickly shed inventories. We attempt to sort financial from nonfinancial explanations with evidence on asymmetries and on balance sheet effects on inventory demand across size classes.