Liquidity Premium, Credit Costs, and Optimal Monetary Policy

Sukjoon Lee

MPRA Paper from University Library of Munich, Germany

Abstract: I study how monetary policy affects firms' external financing decisions. More precisely, I study the transmission mechanism of monetary policy to credit costs in a general equilibrium macroeconomic model where firms issue corporate bonds or obtain bank loans, and corporate bonds are not just stores of value but also serve a liquidity role. The model shows that an increase in the nominal policy rate can lower the borrowing cost in the corporate bond market, while increasing that in the bank loan market, and I provide empirical evidence that supports this result. The model also predicts that a higher nominal policy rate induces firms to substitute corporate bonds for bank loans, which is supported by the existing empirical evidence. In the model, the Friedman rule is suboptimal so that keeping the cost of holding liquidity at a positive level is socially optimal. The optimal policy rate is an increasing function of the degree of corporate bond liquidity.

Keywords: Corporate Finance; Credit Cost; Bank Loan; Corporate Bond; Liquidity Premium; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E43 E44 E51 E52 G12 G21 (search for similar items in EconPapers)
Date: 2020-11-15
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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