Sticky Leverage

Urban Jermann, Lukas Schmid and João Gomes ()
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Lukas Schmid: UCLA

No 40, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: We examine the effects of long-lived nominal debt contracts in a quantitative business cycle model with financial frictions. In our setting, as in reality, firms fund themselves with a mix of nominal defaultable debt and equity securities to issue in every period. Debt is priced fairly taking into account default and inflation risk, but is attractive because of the tax-deductibility of interest payments. Unanticipated inflation changes the real burden of corporate debt and, more significantly, distorts corporate investment and production decisions. These effects are large and very persistent. Interest rates rules stabilize the economy, supporting their popularity with policy makers.

Date: 2014
New Economics Papers: this item is included in nep-dge and nep-mac
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Journal Article: Sticky Leverage (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:40

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