Corporate debt structure and monetary policy in a general equilibrium model

I propose to study the extent to which monetary policy should react to financial market variables (such as asset prices and debt compositions) in a general equilibrium macroeconomic model. The model embeds a microfounded heterogeneous-debt framework developed by Luk and Zheng (2017) in which firms finance their investment with secured or unsecured debt depending on their endogenously-evolving credit history. The central bank uses a simple, implementable monetary policy rule that reacts to inflation, the output gap and financial market variables.

I propose to solve for the optimal monetary policy reaction parameters to these variables and explore their implications. The proposed work injects new life into the long-lasting debate about the relationships between monetary policy and financial markets. The results coming from this exercise may also provide theoretical underpinnings for “leaning against the wind”-type monetary policy.