This paper analyses how macroeconomic and monetary policy shocks affect the default risk of euro-area non-financial companies. The macroeconomic shocks include supply shocks, characterized by economic activity and inflation moving in opposite directions, and demand shocks that push them in the same direction. Monetary policy shocks are measured by variations in the returns of various assets following monetary policy announcements.
The results show that a negative supply shock of one standard deviation and restrictive monetary policy result in an average increase in the firms' default probabilities by about 10 per cent. The smaller companies, the most indebted ones and those with a higher share of financial expenses on gross operating profits are affected to a greater extent. The presence of liquidity reserves, however, mitigates the impact of such shocks.
