Indebted Supply and Monetary Policy: A Theory of Financial Dominance - CEPR RPN European Economic Policy
- Viral Acharya Emil Verner
- 6 May 2025
A webinar organised by CEPR RPN on European Economic Policy, in collaboration with the CEPR RPN on European Financial Architecture and the European and Monetary Union (EMU) Laboratory of the European University Institute (EUI).
Presenters
Viral Acharya* (New York University Stern School of Business) & Emil Verner (MIT Sloan)
*based on a joint paper by Guillaume Plantin (Science Po) and Olivier Wang (New York University Stern School of Business)
Organisers and Moderators
Laura Bottazzi (Bologna University and CEPR)
Giancarlo Corsetti (EUI and CEPR)
Abstract: Past policy decisions may reduce the effectiveness of monetary policy in managing inflation and output, via their impact on how firms adapt their capital structure over time. The paper by Acharya, Plantin and Wang offer insight on how and why the path of interest rates shape both the way firms take decisions on their capital structure and, ex-post, the incidence of financial constraints firms face. This gives rise to "financial dominance" in monetary policy, in 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 the economy is hit by negative demand shocks, the central bank faces dilemma: leaning against the current demand-driven recession implies tightening constraints arising from more indebted supply in the future.