We study theoretically how corporate leverage, especially its cross-sectional heterogeneity, drives aggregate economic outcomes, using a workhorse corporate finance model of investments and defaults. The key endogenous object in our model is the joint distribution of size and leverage. Aggregate shocks filter through this distribution to the rest of the economy, and we identify which cross-sectional leverage moments are important factors for aggregate responses. We analyze one-time unanticipated shocks to monetary and tax policy, focusing on their potential aggregate effects coming from the presence of long-term nominal debt contracts. We find that monetary easing and tax cuts can be stimulative through this channel, but the effectiveness is surprisingly limited. For example, although the Friedman rule is not literally optimal in this setting, it turns out to be approximately optimal through firm’s endogenous balance sheet choices.
|Number of pages||58|
|Publication status||Published - 2021|
|Event||2021 Annual Meeting of the Society for Economic Dynamics - Zoom hosted by University of Minnesota, Minneapolis, United States|
Duration: 1 Jul 2021 → 3 Jul 2021
|Conference||2021 Annual Meeting of the Society for Economic Dynamics|
|Location||Zoom hosted by University of Minnesota|
|Period||01/07/2021 → 03/07/2021|