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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. Charles T. Carlstrom & Timothy Fuerst, 2007. "Asset Prices, Nominal Rigidities, and Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(2), pages 256-275, April.
  2. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  3. Krishnamurthy, Arvind, 2003. "Collateral constraints and the amplification mechanism," Journal of Economic Theory, Elsevier, vol. 111(2), pages 277-292, August.
  4. Gertler, Mark, 1990. "Financial Capacity And Output Fluctuations In An Economy With Multiperiod Financial Relationships," Working Papers 90-44, C.V. Starr Center for Applied Economics, New York University.
  5. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," Working Paper Series WP10-5, Peterson Institute for International Economics.
  6. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  7. Fiorella De Fiore & Oreste Tristani, 2013. "Optimal Monetary Policy in a Model of the Credit Channel," Economic Journal, Royal Economic Society, vol. 123(571), pages 906-931, 09.
  8. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
  9. 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.
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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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