Working Paper: NBER ID: w26471
Authors: Viral V. 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: Monetary Policy; Corporate Leverage; Investment; Shadow Banking; Financial Regulation
JEL Codes: E52; E58; G01; G21; G23; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low monetary policy rate (E52) | Lower cost of capital (G31) |
| Lower cost of capital (G31) | Increased leverage (G19) |
| Increased leverage (G19) | Reduced investment incentives (G31) |
| Reduced investment incentives (G31) | Lower productivity (O49) |
| Low monetary policy rate (E52) | Increased leverage (G19) |
| Low monetary policy rate (E52) | Reduced investment incentives (G31) |
| Low monetary policy rate (E52) | Lower productivity (O49) |