IDEAS home Printed from https://ideas.repec.org/p/fip/fedcwp/1238.html
   My bibliography  Save this paper

Leverage, investment, and optimal monetary policy

Author

Listed:
  • Filippo Occhino
  • Andrea Pescatori

Abstract

We study optimal monetary policy in an economy where firms? debt overhangs lead to under-investment and under-production. The magnitude of this debt-induced distortion varies over the business cycle, rising significantly during recessions. When debt is contracted in nominal terms, this distortion gives rise to a balance sheet channel for monetary policy. In the presence of real and financial shocks, the monetary authority faces a trade-off between inflation and output gap stabilization. The optimal monetary policy rule prescribes that the anticipated component of inflation should be set equal to a target level, while the unanticipated component should rise in response to adverse shocks, smoothing the debt overhang distortion and the output gap.

Suggested Citation

  • Filippo Occhino & Andrea Pescatori, 2012. "Leverage, investment, and optimal monetary policy," Working Papers (Old Series) 1238, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:1238
    DOI: 10.26509/frbc-wp-201238
    as

    Download full text from publisher

    File URL: https://doi.org/10.26509/frbc-wp-201238
    File Function: Persistent link
    Download Restriction: no
    File URL: https://www.clevelandfed.org/-/media/project/clevelandfedtenant/clevelandfedsite/publications/working-papers/2012/wp-1238-leverage-investment-and-optimal-monetary-policy-pdf.pdf
    File Function: Full text
    Download Restriction: no
    File URL: https://libkey.io/10.26509/frbc-wp-201238?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    2. Fiorella De Fiore & Pedro Teles & Oreste Tristani, 2011. "Monetary Policy and the Financing of Firms," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(4), pages 112-142, October.
    3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    4. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    5. Gertler, Mark & Kiyotaki, Nobuhiro, 2010. "Financial Intermediation and Credit Policy in Business Cycle Analysis," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 11, pages 547-599, Elsevier.
    6. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    7. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
    8. Olivier Blanchard & Jordi Galí, 2007. "Real Wage Rigidities and the New Keynesian Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 35-65, February.
    9. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    10. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
    11. Mark Gertler & Nobuhiro Kiyotaki, 2015. "Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy," American Economic Review, American Economic Association, vol. 105(7), pages 2011-2043, July.
    12. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    13. Lamont, Owen, 1995. "Corporate-Debt Overhang and Macroeconomic Expectations," American Economic Review, American Economic Association, vol. 85(5), pages 1106-1117, December.
    14. Moyen, Nathalie, 2007. "How big is the debt overhang problem?," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 433-472, February.
    15. Stewart C. Myers, 2001. "Capital Structure," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 81-102, Spring.
    16. Moritz Schularick & Alan M. Taylor, 2012. "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic Review, American Economic Association, vol. 102(2), pages 1029-1061, April.
    17. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.
    18. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    19. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 647-663.
    20. Occhino, Filippo & Pescatori, Andrea, 2015. "Debt overhang in a business cycle model," European Economic Review, Elsevier, vol. 73(C), pages 58-84.
    21. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    22. Christopher A. Hennessy, 2004. "Tobin's "Q", Debt Overhang, and Investment," Journal of Finance, American Finance Association, vol. 59(4), pages 1717-1742, August.
    23. Meh, Césaire A. & Moran, Kevin, 2010. "The role of bank capital in the propagation of shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 555-576, March.
    24. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Egle Jakucionyte & Sweder van Wijnbergen, 2022. "The macroeconomics of carry trade gone wrong: Corporate and consumer losses in Emerging Europe," Economics of Transition and Institutional Change, John Wiley & Sons, vol. 30(4), pages 773-812, October.
    2. Hamed Ghiaie, 2018. "Shadow Bank run, Housing and Credit Market: The Story of a Recession," THEMA Working Papers 2018-01, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    3. James Bullard & Jacek Suda & Aarti Singh & Costas Azariadis, 2014. "Debt Overhang and Monetary Policy," 2014 Meeting Papers 948, Society for Economic Dynamics.
    4. Occhino, Filippo, 2017. "Debt-overhang banking crises: Detecting and preventing systemic risk," Journal of Financial Stability, Elsevier, vol. 30(C), pages 192-208.
    5. van Wijnbergen, Sweder & Jakucionyte, Egle, 2017. "Debt Overhang, Exchange Rates and the Macroeconomics of Carry Trade," CEPR Discussion Papers 11788, C.E.P.R. Discussion Papers.
    6. João Gomes & Urban Jermann & Lukas Schmid, 2016. "Sticky Leverage," American Economic Review, American Economic Association, vol. 106(12), pages 3800-3828, December.
    7. Occhino, Filippo & Pescatori, Andrea, 2015. "Debt overhang in a business cycle model," European Economic Review, Elsevier, vol. 73(C), pages 58-84.
    8. Occhino, Filippo, 2017. "The 2012 eurozone crisis and the ECB’s OMT program: A debt-overhang banking and sovereign crisis interpretation," European Economic Review, Elsevier, vol. 100(C), pages 337-363.
    9. Filippo Occhino, 2014. "Debt-Overhang Banking Crises," Working Papers (Old Series) 1425, Federal Reserve Bank of Cleveland.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Occhino, Filippo & Pescatori, Andrea, 2015. "Debt overhang in a business cycle model," European Economic Review, Elsevier, vol. 73(C), pages 58-84.
    2. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    3. Eleni Iliopulos & Thepthida Sopraseuth, 2012. "L'intermédiation financière dans l'analyse macroéconomique : le défi de la crise," Économie et Statistique, Programme National Persée, vol. 451(1), pages 91-130.
    4. Atkeson, Andrew G. & Eisfeldt, Andrea L. & Weill, Pierre-Olivier, 2017. "Measuring the financial soundness of U.S. firms, 1926–2012," Research in Economics, Elsevier, vol. 71(3), pages 613-635.
    5. Andrea Silvestrini & Andrea Zaghini, 2015. "Financial shocks and the real economy in a nonlinear world: a survey of the theoretical and empirical literature," Questioni di Economia e Finanza (Occasional Papers) 255, Bank of Italy, Economic Research and International Relations Area.
    6. Andrea Ajello & Nina Boyarchenko & François Gourio & Andrea Tambalotti, 2022. "Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms," Staff Reports 1002, Federal Reserve Bank of New York.
    7. Keiichiro Kobayashi & Tomoyuki Nakajima, 2014. "A macroeconomic model of liquidity crises," KIER Working Papers 876, Kyoto University, Institute of Economic Research.
    8. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.
    9. Michał Brzoza‐Brzezina & Marcin Kolasa, 2013. "Bayesian Evaluation of DSGE Models with Financial Frictions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(8), pages 1451-1476, December.
    10. Schmidt, Sebastian & Wieland, Volker, 2013. "The New Keynesian Approach to Dynamic General Equilibrium Modeling: Models, Methods and Macroeconomic Policy Evaluation," Handbook of Computable General Equilibrium Modeling, in: Peter B. Dixon & Dale Jorgenson (ed.), Handbook of Computable General Equilibrium Modeling, edition 1, volume 1, chapter 0, pages 1439-1512, Elsevier.
    11. Górajski, Mariusz & Kuchta, Zbigniew, 2023. "Coordination and non-coordination risks of monetary and macroprudential authorities: A robust welfare analysis," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).
    12. Beck, Thorsten & Colciago, Andrea & Pfajfar, Damjan, 2014. "The role of financial intermediaries in monetary policy transmission," Journal of Economic Dynamics and Control, Elsevier, vol. 43(C), pages 1-11.
    13. repec:hal:psewpa:halshs-00744047 is not listed on IDEAS
    14. Imen Ben Mohamed & Marine Salès, 2015. "Credit imperfections, labor market frictions and unemployment: a DSGE approach," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01082491, HAL.
    15. repec:hal:spmain:info:hdl:2441/293qice3lj861rvos9ns14n0h0 is not listed on IDEAS
    16. Silvestrini, Andrea & Zaghini, Andrea, 2015. "Financial shocks and the real economy in a nonlinear world: From theory to estimation," Journal of Policy Modeling, Elsevier, vol. 37(6), pages 915-929.
    17. Kirchner Philipp, 2020. "On Shadow Banking and Financial Frictions in DSGE Modeling," Review of Economics, De Gruyter, vol. 71(2), pages 101-133, August.
    18. Kollintzas, Tryphon & Tsoukalas, Konstantinos, 2015. "Bank and Sovereign Risk Interdependence in the Euro Area," CEPR Discussion Papers 10485, C.E.P.R. Discussion Papers.
    19. Hristov, Atanas, 2015. "The high sensitivity of employment to agency costs: The relevance of wage rigidity," Journal of Macroeconomics, Elsevier, vol. 45(C), pages 137-154.
    20. Brzoza-Brzezina, Michał & Kolasa, Marcin & Makarski, Krzysztof, 2013. "The anatomy of standard DSGE models with financial frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 32-51.
    21. Imen Ben Mohamed & Marine Salès, 2015. "Credit imperfections, labor market frictions and unemployment: a DSGE approach," Working Papers hal-01082491, HAL.
    22. Laurent Clerc & Alexis Derviz & Caterina Mendicino & Stephane Moyen & Kalin Nikolov & Livio Stracca & Javier Suarez & Alexandros P. Vardoulakis, 2015. "Capital Regulation in a Macroeconomic Model with Three Layers of Default," International Journal of Central Banking, International Journal of Central Banking, vol. 11(3), pages 9-63, June.

    More about this item

    Keywords

    Business cycles; Monetary policy;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedcwp:1238. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: 4D Library (email available below). General contact details of provider: https://edirc.repec.org/data/frbclus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.