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The Financial Accelerator and the Optimal Lending Contract

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  • Mikhail Dmitriev
  • Jonathan Hoddenbagh

Abstract

In the financial accelerator literature pioneered by Bernanke, Gertler and Gilchrist (1999) entrepreneurs are myopic and lenders suboptimally choose a safe rate of return on their loans. We derive the optimal lending contract for forward looking entrepreneurs and provide three main results. First, under the optimal contract we find that financial frictions do not amplify business cycle fluctuations. Second, we show that shocks to the variance of unobserved idiosyncratic productivity --- so-called ``risk shocks'' --- have little effect on the real economy under the optimal contract. Third, we find that amplification under the suboptimal contract depends on loose monetary policy: when interest rate setting follows a standard Taylor rule, the financial accelerator is significantly dampened or even reversed.

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Bibliographic Info

Paper provided by Job Market Papers in its series 2013 Papers with number pdm9.

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Date of creation: 14 Nov 2013
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Handle: RePEc:jmp:jm2013:pdm9

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  1. Cole, Harold L., 2013. "Self-enforcing stochastic monitoring and the separation of claims," Journal of Monetary Economics, Elsevier, vol. 60(6), pages 632-649.
  2. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  3. Charles T. Carlstrom & Timothy S. Fuerst & Matthius Paustian, 2012. "Privately optimal contracts and suboptimal outcomes in a model of agency costs," Working Paper 1204, Federal Reserve Bank of Cleveland.
  4. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 16270, University Library of Munich, Germany.
  5. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  6. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, vol. 58(2), pages 867-894, 04.
  7. Ricardo Caballero & Arvind Krishnamurthy, 2001. "Smoothing Sudden Stops," NBER Working Papers 8427, National Bureau of Economic Research, Inc.
  8. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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