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Monetary policy and corporate default

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Author Info

  • Bhamra, Harjoat S.
  • Fisher, Adlai J.
  • Kuehn, Lars-Alexander

Abstract

When a corporation issues debt with a fixed nominal coupon, the real value of future payments decreases with the price level. Forward-looking corporate default decisions therefore depend on monetary policy through its impact on expected inflation. We build a general equilibrium economy with deadweight bankruptcy costs that demonstrates how nominal rigidities in corporate debt create an important role for monetary policy even in the absence of standard nominal frictions such as staggered price setting in the output market. Under a passive nominal interest rate peg, the direct effects of a negative productivity shock combine with deflation to produce strong incentives for corporate default. A debt-deflationary spiral results when there are real costs of financial distress. Inflation targeting eliminates this amplification mechanism but full inflation targeting requires permitting the nominal interest rate to depend explicitly on credit market conditions.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 58 (2011)
Issue (Month): 5 ()
Pages: 480-494

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Handle: RePEc:eee:moneco:v:58:y:2011:i:5:p:480-494

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Web page: http://www.elsevier.com/locate/inca/505566

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References

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Cited by:
  1. Georges Dionne & Olfa Maalaoui Chun, 2013. "Default and Liquidity Regimes in the Bond Market during the 2002-2012 Period," Cahiers de recherche 1322, CIRPEE.
  2. Challe, Edouard & Giannitsarou, Chryssi, 2014. "Stock prices and monetary policy shocks: A general equilibrium approach," Journal of Economic Dynamics and Control, Elsevier, vol. 40(C), pages 46-66.

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