Creative Destruction: How monetary policy could help bringing the economic system to a more efficient plan.

In this paper we show how a contraction in monetary policy affects the process of creative destruction. Thereby we use a rise in the Federal Reserve’s policy interest rate as a proxy. We find that firms in the United States on average reduce their long-term debts and that average firm-level productivity increases as a result of a monetary contraction. With the first finding serving as a confirmation of prior research, our second finding validates the theory of creative destruction as firm-level productivity improves after a rise in the policy interest rate. This finding demonstrates a fundamental aspect of the theory of creative destruction. As unproductive firms are not able to meet rising interest expenses anymore, substantial dismissals of employees, divestitures of assets and ultimately liquidations result in a higher average firm-level productivity.