Corporate Debt Prices and the Design of Monetary Policy

Abstract

Should monetary policy respond to corporate credit spreads? We develop and estimate a Bayesian dynamic general equilibrium model with long-term defaultable nominal corporate debt and constrained financial intermediaries. Corporate credit spreads are equilibrium asset prices that summarize firms' financing wedge and market cost of external finance. Because debt is long-term and nominal, monetary policy affects debt valuation, default risk, required returns, and investment. Estimating the model using U.S. macroeconomic and corporate debt-market data, we show that a spread-augmented Taylor rule improves welfare by stabilizing firms' financing costs and substantially reduces the need for aggressive inflation targeting.

Presented at: Vanderbilt University*, Society for Economic Dynamics, Central Bank Research Association, China International Conference in Finance, European Finance Association, American Finance Association

*denotes presentation by co-author

Mentioned by: Knowledge@Wharton