Working Paper: CEPR ID: DP14958
Authors: Viral Acharya; Guillaume Plantin
Abstract: This paper studies a model in which a low monetary policy rate lowers the cost of capital for entrepreneurs, potentially spurring productive investment. Low interest rates, however, also induce entrepreneurs to lever up so as to increase payouts to equity. Whereas such leveraged payouts privately benefit entrepreneurs, they come at the social cost of reducing their incentives thereby lowering productivity and discouraging investment. If leverage is unregulated (for example, due to the presence of a shadow-banking system), then the optimal monetary policy seeks to contain such socially costly leveraged payouts by stimulating investment in response to adverse shocks only up to a level below the first-best. The optimal monetary policy may even consist of “leaning against the wind,” i.e., not stimulating the economy at all, in order to fully contain leveraged payouts and maintain productive efficiency.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low monetary policy rates (E52) | decrease in the cost of capital (G31) |
| decrease in the cost of capital (G31) | spur productive investment (E22) |
| Low monetary policy rates (E52) | increase leverage (G32) |
| increase leverage (G32) | distort incentives (H31) |
| distort incentives (H31) | reduce productivity (O49) |
| reduce productivity (O49) | discourage investment (F21) |
| increase leverage (G32) | lower investment (G31) |
| optimal monetary policy may involve not stimulating the economy (E63) | contain leveraged payouts (G35) |