I study the role of firms' balance sheet liquidity in the transmission of monetary policy to investment. I develop a heterogeneous firm macroeconomic model with financial constraints, debt issuance costs, and differential returns on firms' cash and borrowing. The model matches key novel moments from U.S. firm-level data on liquid asset holdings, debt issuance activity, and investment responses to identified monetary shocks. Counterfactual analysis shows that the rise in U.S. firms' liquid asset holdings over recent decades has significantly increased the relevance of balance sheet liquidity and the behavior of liquid asset returns in monetary transmission.

We study the effects of monetary policy–induced changes in Tobin’s q on corporate investment and capital structure. We develop a theory of the mechanism, provide empirical evidence, evaluate the ability of the quantitative theory to match the evidence, and quantify the relevance for monetary transmission to aggregate investment.