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

  • Carlstrom, Charles T.
  • Fuerst, Timothy S.
  • Paustian, Matthias


    (Federal Reserve Bank of Cleveland)

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

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Length: 33 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:fip:fedcwp:1204
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  1. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Asset prices, nominal rigidities, and monetary policy," Working Paper 0413, Federal Reserve Bank of Cleveland.
  2. 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.
  3. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  4. 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.
  5. 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.
  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. Faia, Ester & Monacelli, Tommaso, 2007. "Optimal interest rate rules, asset prices, and credit frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3228-3254, October.
  9. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
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