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Macroeconomic Effects of Financial Policy

Author

Listed:
  • Yann Algan

    (Sciences Po)

  • Olivier Allais

    (INRA, ALISS)

  • Eva Carceles-Poveda

    (SUNY Stony Brook)

Abstract

This paper studies the effects of financial policy in a model with heterogeneous agents, incomplete markets and portfolio restrictions. For an economy calibrated to replicate key aspects of the US wealth distribution, we find that the quantitative effects of financial policy are relatively small. The reason is that the households determining aggregate behavior are relatively well insured and can therefore offset the actions of the firm by modifying their portfolio allocations. However, financial policy has important effects on asset prices. Whereas a higher level of debt in the capital structure of the firm introduces more risk into the economy by increasing the volatility of the equity return, it enhances the liquidity of households by increasing the supply of bonds. In an economy with a substantial amount of heterogeneity, this last effect dominates and leverage leads to a decrease in the equity premium. This is in contrast to the findings in representative agent models, in which leverage unambiguously increases the premium through a higher equity return volatility. (Copyright: Elsevier)

Suggested Citation

  • Yann Algan & Olivier Allais & Eva Carceles-Poveda, 2009. "Macroeconomic Effects of Financial Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 678-696, October.
  • Handle: RePEc:red:issued:06-51
    DOI: 10.1016/j.red.2009.02.001
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    1. Ivo Bakota, 2020. "Capital Income Taxation with Portfolio Choice," CERGE-EI Working Papers wp668, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    2. Ivo Bakota, 2020. "Avoiding Root-Finding in the Krusell-Smith Algorithm Simulation," CERGE-EI Working Papers wp669, The Center for Economic Research and Graduate Education - Economics Institute, Prague.

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    More about this item

    Keywords

    Incomplete markets; Heterogeneous agents; Financial policy;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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