Corporate Finance and Interest Rate Policy

Piergallini, Alessandro (2024): Corporate Finance and Interest Rate Policy.

Abstract

I develop flexible- and sticky-price general equilibrium models that embody corporate financing decisions affecting firm value because of distortionary taxes. Nominal interest-rate variations impact costs of debt and equity capital asymmetrically and induce firms to modify the financial structure, altering the gap between the (optimization-based) weighted average cost of capital and the real interest rate. Under these circumstances, I demonstrate that passive or mildly active monetary policies ensure aggregate stability. Overly aggressive inflation-fighting actions are destabilizing under sticky prices. Macroeconomic dynamics following either interest-rate normalization or temporary monetary tightening critically depend upon the tax structure and the steady-state debt-equity ratio.

• Item Type: MPRA Paper
• Language: English
• Keywords: Corporate Finance; Firm Financial Structure; Corporate and Personal Taxation; Interest Rate Policy; Equilibrium Dynamics; Monetary Policy Shocks.
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H24 - Personal Income and Other Nonbusiness Taxes and Subsidies; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H25 - Business Taxes and Subsidies

References

Barth, M. J. and V. A. Ramey (2001), “The Cost Channel of Monetary Policy Transmission,” NBER Macroeconomics Annual, 199-239.

Benhabib, J., S. Schmitt-Groh´e and M. Uribe (2001), “Monetary Policy and Multiple Equilibria,” American Economic Review 91, 167-186.

Bernanke, B. S., M. Gertler and S. Gilchrist (1999), “The Financial Accelerator in a Quantitative Business Cycle Framework,” in J. B. Taylor and M. Woodford (Eds.), Handbook of Macroeconomics 1C, 1341-1393, Amsterdam: North-Holland.

Bordo, M., J. H. Cochrane and J. B. Taylor (Eds.) (2024), Getting Monetary Policy Back on Track, Stanford: Hoover Institution Press.

Brock, W. A. and S. J. Turnovsky (1981), “The Analysis of Macroeconomic Policies in Perfect Foresight Equilibrium,” International Economic Review 22,179-209.

Bullard, J. and K. Mitra (2002), “Learning About Monetary Policy Rules,” Journal of Monetary Economics 49, 1105-1130.

Calvo, G. (1983), “Staggered Prices in a Utility-Maximizing Framework,” Journal of Monetary Economics 12, 383-398.

Carlstrom, C. T. and T. Fuerst (1997), “Agency Costs, Net Worth, and Business Cycle Fluctuations: A Computable General Equilibrium Analysis,” American Economic Review 87, 893-910.

Carlstrom, C. T. and T. Fuerst (1998), “Agency Costs and Business Cycles,” Economic Theory 12, 583-597.

Christiano, L. J., M. Eichenbaum and C. L. Evans (2005), “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy 113, 1-45.

Cochrane, J. H. (1998), “A Frictionless View of U.S. Inflation,” NBER Macroeconomics Annual, 323-421.

Cochrane, J. H. (2005), “Money as Stock,” Journal of Monetary Economics 52, 501-528.

Cochrane, J. H. (2023), The Fiscal Theory of the Price Level, Princeton: Princeton University Press.

Copeland, T. E., J. F. Weston and K. Shastri (2013), Financial Theory and Corporate Policy, Pearson.

De Fiore, F. and H. Uhlig. (2011), “Bank Finance versus Bond Finance,” Journal of Money, Credit and Banking 43, 1399-1421.

De Fiore, F. and H. Uhlig. (2015), “Corporate Debt Structure and the Financial Crisis,” Journal of Money, Credit and Banking 47, 1571-1598.

Eichenbaum, M. (1992), “Comments on ‘Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy’ by C. A. Sims,” European Economic Review 36, 1001–1011.

Gali´, J. (2015), Monetary Policy, Inflation and the Business Cycle, Princeton: Princeton University Press.

Gilchrist, S. and E. Zakrajˇsekm (2015), “Customer Markets and Financial Frictions: Implications for Inflation Dynamics,” in Inflation Dynamics and Monetary Policy, Proceedings of the Jackson Hole Economic Policy Symposium.

Jensen, M. C. and W. H. Meckling (1976), “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics 3, 305-360.

Lagos, R., G. Rocheteau and R. Wright (2017), “Liquidity: A New Monetarist Perspective,” Journal of Economic Literature 55, 371-440.

Mendoza, E. G., A. Razin and L. L. Tesar (1994), “Effective Tax Rates in Macroeconomics: Cross-Country Estimates of Tax Rates on Factor Incomes and Consumption,” Journal of Monetary Economics 34, 297-323.

Miller, M. H. and F. Modigliani (1961), “Dividend Policy, Growth, and the Valuation of Shares,” Journal of Business 34, 411-432.

Modigliani, F. and M. H. Miller (1958), “The Cost of Capital, Corporation Finance, and the Theory of Investment”, American Economic Review 48, 261-297.

Osterberg, W. P. (1988), “Tobin’s q, Investment, and the Endogenous Adjustment of Financial Structure, Journal of Public Economics 40, 293-318.

Rabanal, P. (2007), “The Cost Channel of Monetary Policy: Further Evidence for the United States and the Euro Area,” Journal of Economic Dynamics and Control 31, 906-937.

Rocheteau, G. and E. Nosal (2017), Money, Payments, and Liquidity, Cambridge, MA: MIT Press.

Rocheteau, G., R.Wright and C. Zhang (2018), “Corporate Finance and Monetary Policy,” American Economic Review 108, 1147-1186.

Schmitt-Groh´e, S. and M. Uribe (2022), “The Effects of Permanent Monetary Shocks on Exchange Rates and Uncovered Interest Rate Differentials,” Journal of International Economics 135, 103560.

Sims, C. A. (1992), “Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy,” European Economic Review 36, 975-1000.

Sims, C. A. (1994), “A Simple Model for the Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy,” Economic Theory 4, 381-399.

Smith, C. W. and J. B. Warner (1979), “On Financial Contracting: An Analysis of Bond Covenants,” Journal of Financial Economics 7, 117-161.

Taylor, J. B. (1993), “Discretion Versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy 39, 195.214.

Taylor, J. B. (Ed.) (1999), Monetary Policy Rules, Chicago: University of Chicago Press.

Tirole, J. (2006), The Theory of Corporate Finance, Princeton and Oxford: Princeton University Press.

Trabandt, M. and H. Uhlig (2011), “The Laffer Curve Revisited,” Journal of Monetary Economics 58, 305-327.

Turnovsky, S. J. (1987), “Monetary Growth, Inflation, and Economic Activity in a Dynamic Macro Model,” International Economic Review 28, 707-730.

Walsh, C. E. (2017), Monetary Theory and Policy, Cambridge: The MIT Press.

Woodford, M. (1994), “Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy,” Economic Theory 4, 345-380.

Woodford, M. (1995) “Price Level Determinacy without Control of a Monetary Aggregate,” Carnegie Rochester Conference Series on Public Policy 43, 1-46.

Woodford, M. (2003), Interest and Prices, Princeton: Princeton University Press.

Yun, T. (1996) “Nominal Price Rigidity, Money Supply Endogeneity, and Business Cycles,” Journal of Monetary Economics 37, 345-370.