Implications of Corporate Indebtedness for Monetary Policy
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.
|Date of creation:||Feb 1990|
|Publication status:||published as "Implications of Increasing Corporate Indebtedness for Monetary Policy." From Group of Thirty Occasional Papers, No. 29, pp. 1-40, (1990).|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
- Friedman, Benjamin M, 1988. "Lessons on Monetary Policy from the 1980s," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 51-72, Summer.
- Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-254, April.
- Milton Friedman & Anna J. Schwartz, 1963. "A Monetary History of the United States, 1867–1960," NBER Books, National Bureau of Economic Research, Inc, number frie63-1, November.
- Bernanke, Ben S, 1983.
"Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression,"
American Economic Review,
American Economic Association, vol. 73(3), pages 257-276, June.
- Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
- Ben S. Bernanke & John Y. Campbell, 1988. "Is There a Corporate Debt Crisis?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 83-140.
- Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-334, June.
- Benjamin M. Friedman, 1988. "Lessons On Monetary Policy From The 1980's," NBER Working Papers 2551, National Bureau of Economic Research, Inc.
- Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
- Jensen, Michael C, 1988. "Takeovers: Their Causes and Consequences," Journal of Economic Perspectives, American Economic Association, vol. 2(1), pages 21-48, Winter. Full references (including those not matched with items on IDEAS)