Monetary Policy Uncertainty and New Firm Entry in China: Measuring Monetary Policy Uncertainty with the Stochastic Volatility Regime-Switch Model

Monetary policy uncertainty represents the implicit costs for monetary policy adjustment. With the extensive margin perspective, this study focuses on how monetary policy uncertainty affects new firm entry through the real options and financial friction channels. Using a regime-switch model with stochastic volatility to measure the monetary policy uncertainty in China and using the Chinese Industrial Enterprises Database to measure the new firm entry rate at the city-industry-year level, the empirical results show that the monetary policy uncertainty significantly inhibits the new firm entry, the result is robust to endogeneity test and robustness tests. The real option mechanism and the financial friction mechanism are effective transmission channels that monetary policy uncertainty inhibits the new firm entry. From the real options theory perspective, the inhibitory effect is more pronounced in industries with higher asset irreversibility or lower entry barriers. Further, extending the real options theory from the risk perception perspective, the results show that improvement in the macroeconomic environment weakens the inhibitory effect, and perceived uncertainty magnifies the inhibitory effect. From the financial frictions theory, the results show that the macro credit resources availability and the regional financial development mitigate the inhibitory effect. Further, using the ownership type to proxy for financial constraints, the result shows that the inhibitory effect is stronger among non-state firms. The study enriches the understanding of the extensive marginal effect of monetary policy uncertainty, and has important implications for preventing and resolving risks and optimizing monetary policy operation.