Advanced Search
MyIDEAS: Login

Implications of Corporate Indebtedness for Monetary Policy

Contents:

Author Info

  • Benjamin M. Friedman
Registered author(s):

    Abstract

    The extraordinary increase in reliance on debt by U.S. business in the 1980s has generated widespread concern that overextended borrowers may become unable to meet their obligations and that proliferating defaults could then lead to some kind of rupture of the financial system, with ensuing consequences for the nonfinancial economy as well. The thesis advanced in this paper, however, is that the more likely threat posed by a continuing rapid rise of corporate indebtedness is instead a return to rapid price inflation. In particular, a review of recent developments lead to four specific conclusions: First, problems of debt service within the private sector are more likely to arise among business borrowers, not households. Because businesses, and especially corporations, have used much of the proceeds of their borrowing merely to pay down their own or other firms' equity, their interest payments have risen to postwar record levels compared to either their earnings or their cash flows. Second, despite these high debt service burdens, debt default on a scale large enough to threaten the financial system as a whole is unlikely in the absence of a general economic downturn. But the sharp increase in indebtedness has made U.S. businesses crucially dependent on continued strong earnings growth. Third, the consequent need to prevent a serious recession -- so as to preclude the possibility of a systemic debt default -- will increasingly constrain the Federal Reserve System's conduct of monetary policy. The Federal Reserve's reluctance to risk a situation of spreading business (and LDC) debt defaults, especially with the U.S. commercial banking system in its current exposed position, will increasingly prevent it from either acquiescing in a recession or bringing one about on its own initiative. Fourth, over time this constraint will severely limit the ability of monetary policy to contain or reduce price inflation. Episodes of disj in the United States since World War II have invariably involved business recessions, including declines in business earnings and increases in bankruptcies and defaults. If the economy's financial system has become fragile to withstand any but the shortest and shallowest recession, it is unlikely to be able to support a genuine attack on inflation by monetary policy.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.nber.org/papers/w3266.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3266.

    as in new window
    Length:
    Date of creation: Jun 1990
    Date of revision:
    Handle: RePEc:nbr:nberwo:3266

    Note: ME
    Contact details of provider:
    Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Email:
    Web page: http://www.nber.org
    More information through EDIRC

    Related research

    Keywords:

    References

    No references listed on IDEAS
    You can help add them by filling out this form.

    Citations

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

    Cited by:
    1. Adalbert Winkler, 2010. "The Financial Crisis : A Wake-Up Call for Strengthening Regional Monitoring of Financial Markets and Regional Coordination of Financial Sector Policies?," Finance Working Papers 22022, East Asian Bureau of Economic Research.
    2. Benjamin M. Friedman & Kenneth N. Kuttner, 1994. "Why Does the Paper-Bill Spread Predict Real Economic Activity?," NBER Working Papers 3879, National Bureau of Economic Research, Inc.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:3266. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

    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 references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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