An argument about monetary policy I had never heard before

This paper studies a model in which a low monetary policy rate lowers the cost of capital for entrepreneurs, potentially spurring productive investment. Low interest rates, however, also induce entrepreneurs to lever up so as to increase payouts to equity. Whereas such leveraged payouts privately benefit entrepreneurs, they come at the social cost of reducing their incentives thereby lowering productivity and discouraging investment. If leverage is unregulated (for example, due to the presence of a shadow-banking system), then the optimal monetary policy seeks to contain such socially costly leveraged payouts by stimulating investment in response to adverse shocks only up to a level below the first-best. The optimal monetary policy may even consist of “leaning against the wind,” i.e., not stimulating the economy at all, in order to fully contain leveraged payouts and maintain productive efficiency.

That is from a new NBER working paper by Viral V. Acharya and Guillaume Plantin.

Since I don’t see share buybacks as “draining” the economy of investment (the funds simply get recycled to other companies and ventures), I can’t agree with this argument.  Still, if you are worried about buybacks, perhaps you should think twice about always pushing for easier monetary policy.


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