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Optimal contracts, aggregate risk and the financial accelerator

Author

Listed:
  • Timothy Fuerst

    (University of Notre Dame and Federal Reserve Bank of Cleveland)

  • Charles Carlstrom

    (Federal Reserve Bank of Cleveland)

  • Matthias Paustian

    (Federal Reserve Board)

Abstract

This paper derives the optimal lending contract in the financial accelerator model of Bernanke, Gertler and Gilchrist (BGG). The optimal contract includes indexation to the aggregate return on capital, household consumption, and the return to internal funds. This triple indexation results in a dampening of fluctuations in leverage and the risk premium. Hence, compared to the contract originally imposed by BGG, the privately optimal contract implies essentially no financial accelerator.

Suggested Citation

  • Timothy Fuerst & Charles Carlstrom & Matthias Paustian, 2014. "Optimal contracts, aggregate risk and the financial accelerator," Bank of England working papers 517, Bank of England.
    • Handle: RePEc:boe:boeewp:0517
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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