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Corporate legacy debt, inflation, and the efficacy of monetary policy

Goodhart, C. A. E., Peiris, M. U., Tsomocos, Dimitrios P and Wang, Xuan (2021) Corporate legacy debt, inflation, and the efficacy of monetary policy. Monetary Economics and Fluctuations (DP16799). Centre for Economic Policy Research, London, UK.

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Abstract

The COVID-19 pandemic has coincided with a rapid increase in indebtedness. Although the rise in public debt and its policy implications have received much attention recently, the rise in corporate debt has received less so. We argue that high levels of corporate debt may impede the transmission mechanism of monetary policy and make it less effective in controlling inflation. In an environment with working capital financing requirements, when firms’ indebtedness is sufficiently high, the income effect of higher nominal interest rates offsets or even dominates its usual negative substitution effect on aggregate demand and is quantitatively important. This mechanism is independent of standard financial and nominal frictions and enhances the trade-off between inflation and output stabilisation.

Item Type: Monograph (Discussion Paper)
Official URL: https://cepr.org/content/monetary-economics-and-fl...
Additional Information: © 2021 The Authors
Divisions: Financial Markets Group
Subjects: H Social Sciences > HG Finance
H Social Sciences > HJ Public Finance
H Social Sciences > HC Economic History and Conditions
JEL classification: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level; Inflation; Deflation
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects)
G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy; Liquidation
Date Deposited: 14 Dec 2021 09:42
Last Modified: 14 Dec 2021 09:54
URI: http://eprints.lse.ac.uk/id/eprint/112955

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