Effects of Monetary Policy on Investment Dynamics in Latin American Economies Through a Model with Heterogeneous Firms

This study examines how firms’ financial heterogeneity shapes the transmission of monetary policy to investment in Latin American economies. It develops an extended theoretical model with heterogeneous firms, calibrated for Latin American economies, and validates it empirically through local projection models. These projections are applied to both a dataset of 72 of the most representative firms from the six analyzed Latin American economies and simulated data from the theoretical model, enabling direct comparison of the results. The research yields three main findings. First, it shows that financial heterogeneity is crucial and determines how firms respond to a monetary shock. Firms with fragile structures or high levels of indebtedness tend to restrict investment following monetary expansions, whereas firms with stronger financial positions or greater distance to default tend to increase it. The aggregate effect depends on the distribution of financial structures in the economy and which group dominates. Second, a transmission mechanism is identified via a financial channel based on a price–quantity sequence. The drop in the real rate compresses spreads and raises the price of capital; if financial constraints are active, the monetary relief is used to repair balance sheets rather than to invest; otherwise, the stimulus quickly translates into investment. Finally, the study shows that ignoring heterogeneity—as in representative–agent models—leads to a significant overestimation of both the magnitude and persistence of investment responses to monetary policy shocks.