Reallocation, Financial Frictions, and Unconventional Monetary Policy

We provide evidence that tighter monetary shocks reduce allocative efficiency, however, the effect of these shocks differs by firm characteristics such as markup, size, and age of firms. To identify the effect of these shocks, we use the Structural Vector Autoregressive (SVAR) model and the local projections using instrumental variables (LP-IV). Both estimation techniques emphasize high-frequency data from financial markets in constructing instruments that provide random variation in monetary policy indicators. We document that calculated allocative efficiency using publicly-listed firms from Compustat does not have a significant additive measurement error. We establish that a one-standard-deviation surprise monetary tightening reduces allocative efficiency by approximately one percent. By applying a Bayesian SVAR, we also find that the Fed's information about the contemporaneous economic outlook strongly impacts allocative efficiency