The Labor Share is a Catalyst for Monetary Policy: Two Million Firms' Production Dynamics

We study the role of firm heterogeneity and cost structure in determining the transmission of monetary policy. Using local projections and high dimensional fixed effects, we show that a one standard deviation contractionary monetary policy shock decreases firms' labor share by 0.4 percent, on average. However, reactions are heterogeneous along two dimensions: The labor share is most informative to discriminate firms by their response in payroll expenses, firms' leverage is most informative to discriminate by their response in value added. We interpret these findings by theorizing differential effects of factor input costs. Our results inform the policy debate on transmission and redistribution effects of monetary policy, and suggest that the effectiveness of monetary policy may depend on the labor intensity of production.