Zombie Credit and (Dis-)Inflation: Evidence from Europe

Abstract

We show that cheap credit to impaired firms has a disinflationary effect. By helping distressed firms to stay afloat, ``zombie credit'' creates excess production capacity reducing, in turn, prices and markups. Granular European inflation and firm-level data confirms this mechanism. At the industry-country level, a rise of zombie credit is associated with a decrease in product prices, markups, firm default, entry, and productivity, and an increase in input costs and sales. Without a rise in zombie credit, inflation in Europe would have been 0.4 percentage points higher post-2012. We also document adverse spillover effects from zombie to healthy firms.

Keywords: Zombie Lending, Under-capitalized Banks, Disinflation, Firm Productivity, Eurozone Crisis