Corporate Legacy Debt, Inflation, and the Efficacy of Monetary Policy

Charles Goodhart, Udara Peiris, Dimitrios Tsomocos and Xuan Wang

No 16799, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The COVID-19 pandemic has coincided with a rapid increase in indebtedness. Although the rise in public debt and its policy implications have recently received much attention, the rise in corporate debt has received less so. We argue that high levels of corporate debt may impede the transmission mechanism of monetary policy and make it less effective in controlling inflation. In an environment with working capital financing requirements, when firms’ indebtedness is sufficiently high, the income effect of higher nominal interest rates offsets or even dominates its usual negative substitution effect on aggregate demand and is quantitatively important. This mechanism is independent of standard financial and nominal frictions and aggravates the trade-off between inflation and output stabilisation.

Keywords: Corporate indebtedness; Debt inflation; Working capital; Monetary transmission mechanism; Income effect; Taylor principle (search for similar items in EconPapers)
JEL-codes: E31 E44 E52 G33 (search for similar items in EconPapers)
Date: 2022-03
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Working Paper: Corporate legacy debt, inflation, and the efficacy of monetary policy (2021)
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