This paper studies how a large increase in the price level is transmitted to the real economy through firm balance sheets. Using newly digitized macro- and micro-level data from the German inflation of 1919–1923, we show inflation led to a large reduction in real debt burdens and bankruptcies. Firms with higher nominal liabilities at the onset of inflation experienced a larger decline in interest expenses, a relative increase in their equity values, and higher employment during the inflation. The results are consistent with real effects of a debt-inflation channel that operates even when prices and wages are flexible. (JEL D22, E23, E31, G32, N14, N24)

ABSTRACT Corporate credit lines are drawn more heavily when funding markets are stressed. This elevates expected bank funding costs. We show that credit supply is dampened by the associated debt‐overhang cost to bank shareholders. Until 2022, this impact was reduced by linking the interest paid on lines to a credit‐sensitive reference rate like the London interbank offered rate (LIBOR). We show that transition to risk‐free reference rates may exacerbate this friction. The adverse impact on credit supply is offset if drawdowns are expected to be deposited at the same bank, which happened at some of the largest banks during the global financial crisis and COVID recession.