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

Author

Listed:
  • Charles A.E. Goodhart

    (Financial Markets Group, London School of Economics and CEPR)

  • M. Udara Peiris

    (Oberlin College)

  • Dimitrios P. Tsomocos

    (Saïd Business School and St. Edmund Hall, University of Oxford)

  • Xuan Wang

    (Vrije Universiteit Amsterdam and Tinbergen Institute)

Abstract

We investigate how corporate legacy debt, through heterogeneous household portfolios, affects monetary policy’s ability to control inflation. We find that (1) corporate debt generates an income effect that counters the traditional substitution effect, reducing the effectiveness of rate changes on inflation; (2) higher corporate debt exacerbates the trade-off between output and inflation stabilization. The income is positive on aggregate demand and inflation despite declining output. Local projections using U.S. monetary policy shocks show that over six quarters the cumulative difference in output and inflation for high and low corporate debt-to-household asset ratios is 3 percent and 1.2 percent.

Suggested Citation

  • Charles A.E. Goodhart & M. Udara Peiris & Dimitrios P. Tsomocos & Xuan Wang, 2024. "Corporate Legacy Debt, Inflation, and the Efficacy of Monetary Policy," Tinbergen Institute Discussion Papers 24-071/VI, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20240071
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    References listed on IDEAS

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    5. Kashyap, Anil K & Stein, Jeremy C & Wilcox, David W, 1993. "Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance," American Economic Review, American Economic Association, vol. 83(1), pages 78-98, March.
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    Cited by:

    1. Goodhart, Charles A.E. & Tsomocos, Dimitrios P. & Wang, Xuan, 2023. "Bank credit, inflation, and default risks over an infinite horizon," Journal of Financial Stability, Elsevier, vol. 67(C).

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    More about this item

    Keywords

    Household heterogeneity; Inflation; Monetary policy; Corporate debt; Giffen good;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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