Finance Seminar with Olivier Wang, New York University, Stern School of Business

The Department of Finance is proud to announce the upcoming seminar with Oliver Wang, New York University, Stern School of Business.

Oliver Wang will present: Indebted Supply and Monetary Policy: A Theory of Financial Dominance

Abstract: 
We develop a New Keynesian model with financial frictions to explore the concept of “financial dominance” in monetary policy. Our theory is based on how interest rates affect firms through both their ex-ante capital structure decisions and their ex-post financial constraints. Ex ante, firms have a “market timing” motive to exploit differences between the cost of debt and equity, leading to increased leverage during periods of monetary easing. Ex post, when a large share of firms’ assets have been encumbered to finance long-term investments through debt, rising interest rates reduce firms’ remaining debt capacity, diminishing their ability to finance production. Monetary policy contractions thus induce an endogenous cost channel whose strength depends on past financial conditions. Financial dominance takes two forms: (i) responding to inflationary shocks when supply is indebted requires a higher policy rate and a starker drop in output, which makes the central bank less willing to tame inflation; (ii) when faced with negative demand shocks a priori, the central bank encounters a dilemma between easing the current demand-driven recession and tightening future constraints driven by indebted supply. Our model highlights how the effectiveness of monetary policy in managing inflation and output may be constrained by past policy decisions and their impact on firms’ capital structures.

Location:
Solbjerg Plads 3
2000 Frederiksberg
Room: SPs07

More information will follow.