When firms finance using long-term nominal debt issued by financial intermediaries, changes in expected inflation lead to a wealth transfer across sectors. Higher expected inflation decreases firms’ real liabilities and default risk, which helps reduce debt overhang. However, it hurts intermediaries’ real assets, leading to a contraction in credit supply. We theoretically demonstrate that intermediary financing conditions play a key role in the transmission of nominal shocks, influencing the premium investors require for bearing inflation risk. We provide empirical evidence supporting our novel inflation transmission mechanism and connect our findings to the banking stress of 2023. We also show that Taylor rules responding to both financial and real variables can help stabilise our economy.

We document that the increasing polarization in Tobin’s Q within industries is closely connected to the growing divergence in rents and the emergence of superstar firms over the past four decades, while discount rates and growth rates did not exhibit the same increasing dispersion. We explain these industry polarization trends in an estimated general equilibrium model where each industry consists of large superstar oligopolists and small monopolistically competitive firms with endogenous transitions between them. Small firms make investments in speculative innovation to increase their probability of becoming superstars. Our model estimation finds that rising entry barriers in both small and superstar firms contribute to rising polarization in markups, but the rising barriers to creating small firms and increasing tastes for goods produced by superstars account for most of the divergence in Q. Stunting the creation of small firms generates greater incentives for speculative innovation, magnifying the impact of market power dispersion on industry polarization in Q.

We develop a capital structure model in which firms differ in their ability to adjust output prices. Firms with inflexible prices are more exposed to nominal and real shocks, leading to lower leverage, shorter debt maturity, higher cost of debt, tighter covenants, and greater precautionary cash holdings. Shocks to cash flow volatility raise the cost of debt more for firms with less pricing flexibility. We empirically confirm these predictions: Firms with inflexible prices experience significantly larger increases in credit spreads following monetary policy shocks and the 2008 Lehman Brothers bankruptcy, especially when they face high preshock rollover risk.