Monetary Policy and the Financing of Firms

50 Pages Posted: 8 Dec 2009

See all articles by Fiorella De Fiore

Fiorella De Fiore

Bank for International Settlements (BIS) - Monetary and Economic Department

Pedro Teles

Federal Reserve Bank of Chicago; Centre for Economic Policy Research (CEPR)

Oreste Tristani

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: December 8, 2009

Abstract

How should monetary policy respond to changes in financial conditions? In this paper we consider a simple model where firms are subject to idiosyncratic shocks which may force them to default on their debt. Firms’ assets and liabilities are denominated in nominal terms and predetermined when shocks occur. Monetary policy can therefore affect the real value of funds used to finance production. Furthermore, policy affects the loan and deposit rates. We find that allowing for short-term inflation volatility in response to exogenous shocks can be optimal; that the optimal response to adverse financial shocks is to lower interest rates, if not at the zero bound, and to engineer a short period of inflation; that the Taylor rule may implement allocations that have opposite cyclical properties to the optimal ones.

Keywords: Financial stability, debt deflation, bankruptcy costs, price level volatility, optimal monetary policy, stabilization policy

JEL Classification: E20, E44, E52

Suggested Citation

De Fiore, Fiorella and Teles, Pedro and Tristani, Oreste, Monetary Policy and the Financing of Firms (December 8, 2009). ECB Working Paper No. 1123, Available at SSRN: https://ssrn.com/abstract=1515810 or http://dx.doi.org/10.2139/ssrn.1515810

Fiorella De Fiore (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Pedro Teles

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States
312-322-2947 (Phone)
312-322-2357 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Oreste Tristani

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)

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