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Privately optimal contracts and suboptimal outcomes in a model of agency costs

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  • Charles T. Carlstrom
  • Timothy S. Fuerst
  • Matthius Paustian

Abstract

This paper derives the privately optimal lending contract in the celebrated fi nancial accelerator model of Bernanke, Gertler and Gilchrist (1999). The privately optimal contract includes indexation to the aggregate return on capital and household consumption. Although privately optimal, this contract is not welfare maximizing as it exacerbates fluctuations in real activity. The household’s desire to hedge business cycle risk, leads, via the fi nancial contract, to greater business cycle risk. The welfare cost of the privately optimal contract (when compared to the planner outcome) is quite large. A countercyclical tax on lender profi ts comes close to achieving the planner outcome

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Bibliographic Info

Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1204.

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Date of creation: 2012
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Handle: RePEc:fip:fedcwp:1204

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Keywords: Contracts ; Financial markets;

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  1. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  2. Tommaso Monacelli & Ester Faia, 2005. "Optimal Interest Rate Rules, Asset Prices and Credit Frictions," Computing in Economics and Finance 2005 452, Society for Computational Economics.
  3. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," American Economic Review, American Economic Association, vol. 100(2), pages 403-07, May.
  4. De Fiore, Fiorella & Tristani, Oreste, 2009. "Optimal monetary policy in a model of the credit channel," Working Paper Series 1043, European Central Bank.
  5. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
  6. Gertler, Mark, 1992. "Financial Capacity and Output Fluctuations in an Economy with Multi-period Financial Relationships," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 455-72, July.
  7. Krishnamurthy, Arvind, 2003. "Collateral constraints and the amplification mechanism," Journal of Economic Theory, Elsevier, vol. 111(2), pages 277-292, August.
  8. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Asset prices, nominal rigidities, and monetary policy," Working Paper 0413, Federal Reserve Bank of Cleveland.
  9. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
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Cited by:
  1. Mikhail Dmitriev & Jonathan Hoddenbagh, 2013. "The Financial Accelerator and the Optimal Lending Contract," 2013 Papers pdm9, Job Market Papers.

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