Inflation Risk and the Finance-Growth Nexus

77 Pages Posted: 11 Mar 2021 Last revised: 24 Apr 2024

See all articles by Alexandre Corhay

Alexandre Corhay

University of Toronto - Rotman School of Management

Jincheng Tong

University of Toronto

Date Written: April 24, 2024

Abstract

When firms finance using long-term nominal debt issued by financial intermediaries, changes in expected inflation lead to a wealth transfer across sectors. Higher expected inflation decreases firms' real liabilities and default risk, which helps reduce debt overhang. However, it hurts intermediaries' real assets, leading to a contraction in credit supply. We theoretically demonstrate that intermediary financing conditions play a key role in the transmission of nominal shocks, influencing the premium investors require for bearing inflation risk. We provide empirical evidence supporting our novel inflation transmission mechanism. We also show that Taylor rules responding to both financial and real variables can help stabilize our economy.

Keywords: Inflation, inflation risk premium, asset prices, credit risk, debt deflation, financial intermediation, monetary policy, general equilibrium model, recursive preferences.

JEL Classification: E12, E31, E44, E52, G01, G32, G35

Suggested Citation

Corhay, Alexandre and Tong, Jincheng, Inflation Risk and the Finance-Growth Nexus (April 24, 2024). Rotman School of Management Working Paper No. 3795679, Available at SSRN: https://ssrn.com/abstract=3795679 or http://dx.doi.org/10.2139/ssrn.3795679

Alexandre Corhay (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
4169780512 (Phone)

Jincheng Tong

University of Toronto ( email )

Toronto, Ontario M5S1L1
Canada

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