Limited Nominal Indexation of Optimal Financial Contracts

Césaire A Meh, Vincenzo Quadrini and Yaz Terajima

Journal of the European Economic Association, 2024, vol. 22, issue 2, 575-616

Abstract: When financial contracts are not fully enforceable and firms observe their own nominal sales before the observation of the aggregate nominal price, the optimal financial contract is not fully indexed to inflation. Because of the limited nominal indexation, which is endogenous in the model, unanticipated inflation affects aggregate investment and future economic activity. The macroeconomic volatility induced by price uncertainty, however, is not monotone: It first increases and then decreases with nominal price uncertainty. We also show that the degree of nominal indexation declines with real idiosyncratic volatility and the impact of an inflation shock decreases with nominal indexation. Using firm-level data from Canada, we find that both predictions are supported by the data.

Date: 2024
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Related works:
Working Paper: Limited Nominal Indexation of Optimal Financial Contracts (2019)
Working Paper: Limited Nominal Indexation of Optimal Financial Contracts (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:oup:jeurec:v:22:y:2024:i:2:p:575-616.

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