Monetarypolicyandcorporatedefault$

When acorporationissuesdebtwithafixednominalcoupon,therealvalueoffuture paymentsdecreaseswiththepricelevel.Forward-lookingcorporatedefaultdecisions thereforedependonmonetarypolicythroughitsimpactonexpectedinflation.Webuilda generalequilibriumeconomywithdeadweightbankruptcycoststhatdemonstrateshow nominalrigiditiesincorporatedebtcreateanimportantroleformonetarypolicyeveninthe absence ofstandardnominalfrictionssuchas staggeredpricesettingintheoutputmarket. Under apassivenominalinterestratepeg,thedirecteffectsofanegativeproductivityshock combine withdeflationtoproducestrongincentivesforcorporatedefault.Adebt- deflationaryspiralresultswhentherearerealcostsoffinancialdistress.Inflationtargeting eliminates thisamplificationmechanismbutfull inflationtargetingrequirespermittingthe nominalinterestratetodependexplicitlyoncreditmarketconditions