Co-authored by Charles Goodhart, Udara Peiris, Dimitri Tsomocos and Xuan Wang, the paper is titled Corporate legacy debt, inflation, and the efficacy of monetary policy. It argues that high levels of corporate debt may render contractionary monetary policy less effective in controlling inflation, especially when there is a large volume of corporate debt in the economy.
The COVID-19 pandemic has seen public sector debt levels rise to historic levels and concern has been expressed about the implications of this both for public finance and inflation. However, alongside the increase in public debt there has been an increase in corporate debt – the implications of which has received far less attention. Corporate debt has been increasing globally since 2007, but the pandemic crisis has led to a further sharp increase. US corporate indebtedness rose by 12.5% between December 2018 and December 2020, much more than its total increase in the entire decade leading up to COVID-19.
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Against this backdrop, inflation has risen. In Q2 2021, US CPI inflation has jumped to a 13-year high, and UK inflation has topped the Bank of England’s inflation target. While the link between public debt and inflation can be analysed through models such as set out in the Fiscal Theory of the Price Level, there is little available on the role that corporate debt might play in hindering the control of inflation.
In their paper, the authors argue that corporate indebtedness poses a challenge for monetary policy in two ways. First, it introduces an additional income effect across heterogenous households that shifts the aggregate supply curve and renders it more elastic. This effect counteracts the traditional substitution effect on dampening aggregate demand, thus affecting the overall effectiveness of raising the policy rate. Second, it creates a greater trade-off between output and inflation stabilisation that requires a reassessment of policy priorities.
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.png "Controlling inflation: VOXeu published a paper co-authored with Associate Professor of ICEF Udara Peiris")