We provide novel empirical evidence that firms' investment is more responsive to
surprise changes in monetary policy when a higher fraction of their debt matures. In
a heterogeneous firm New Keynesian model with financial frictions and endogenous
debt maturity, two channels explain this finding: (1.) Firms with more maturing debt
roll over more debt and are therefore more exposed to fluctuations in the real interest
rate (roll-over risk). (2.) Firms with shorter debt maturity have higher default risk
in equilibrium and therefore react more strongly to changes in the real burden of
outstanding nominal debt (debt overhang). The aggregate effectiveness of monetary
policy depends on the joint distribution of debt maturity and default risk across firms.
Business credit lags GDP growth by about one year. This contributes to high
leverage during recessions and slow deleveraging. We show that a model in which
firms use risky long-term debt replicates this slow adjustment of firm debt. In the
model, slow-moving debt has important effects for real activity. High levels of firm
debt issued during expansions are only gradually reduced during recessions. This
generates an adverse feedback loop between high default rates and low investment
and thereby amplifies the downturn. Sluggish deleveraging slows down the recovery.
The equilibrium is constrained inefficient because firms exert an externality on the
holders of previously issued debt. The constrained efficient allocation substantially
reduces macroeconomic volatility.
We introduce long-term debt and a maturity choice into a dynamic model of
production, firm financing, and costly default. Long-term debt saves roll-over costs
but increases future leverage and default rates because of a commitment problem.
The model generates rich distributions of maturity choices, leverage ratios, and
credit spreads across firms. It explains why larger and older firms borrow at longer
maturities, have higher leverage, and pay lower credit spreads. Firms' maturity
choice matters for policy: A financial reform which increases investment and output
in a standard model of short-term debt can have the opposite effect in a model
with short-term debt and long-term debt.
This paper studies a model of endogenous bank opacity. Why do banks choose to hide their risk
exposure from the public? And should policy makers force banks to be more transparent? In the model,
bank opacity is costly because it encourages banks to take on too much risk. But opacity also reduces
the incidence of bank runs (for a given level of risk taking). Banks choose to be inefficiently opaque
if the composition of their asset holdings is proprietary information. In this case, policy makers can
improve upon the market outcome by imposing public disclosure requirements (such as Pillar Three of
Basel II). However, full transparency maximizes neither efficiency nor stability. The model can explain
why empirically a higher degree of bank competition leads to increased transparency.
