Lending Relationships and Optimal Monetary Policy

Abstract

We construct and calibrate a monetary model of corporate finance with endogenous formation of lending relationships. The equilibrium features money demands by firms that depend on their access to credit and a pecking order of financing means. We describe the mechanism through which monetary policy affects the creation of relationships and firms’ incentives to use internal or external finance. We study optimal monetary policy following an unanticipated destruction of relationships under different commitment assumptions. The Ramsey solution uses forward guidance to expedite creation of new relationships by committing to raise the user cost of cash gradually above its long-run value. Absent commitment, the user cost is kept low, delaying recovery.

A Ramsey Theory of Financial Distortions

“…We analyze optimal liquidity policy related to a recent literature that links government policy and corporate finance. There, firms are also subject to idiosyncratic investment opportunities, financed internally with money (or government bonds) and externally through intermediaries in frictional capital markets (see, e.g., Rocheteau et al, 2018;Bethune et al, 2022). Our discussion highlights the effect of a complete set of distortionary tax system and the implied government debt dynamics.…”

A Model of Supply Chain Finance

“…A lower nominal interest rate prompts firms to hold more cash, which helps to negotiate a favourable loan term with the bank. Bethune, Rocheteau, Wong and Zhang (2021) highlight a monetary channel through which a lower nominal interest rate decreases the banks' incentive to create lending relationships with firms who have a stronger bargaining position. Our model uncovers a novel channel of monetary policy transmission to corporate finance -the provision of trade credit.…”