Financial Intermediary Balance Sheet Management
We consider a simple variant of the standard real business cycle model in which shareholders hire a self-interested executive to manage the firm on their behalf. A generic family of compensation contracts similar to those employed in practice is studied. When compensation is convex in the firm’s own dividend (or share price), a given increase in the firm’s output generated by an additional unit of physical investment results in a more than proportional increase in the manager’s income. Incentive contracts of sufficient yet modest convexity are shown to result in an indeterminate general equilibrium, one in which business cycles are driven by self-fulfilling fluctuations in the manager’s expectations that are unrelated to the economy’s fundamentals. Arbitrarily large fluctuations in macroeconomic variables may result. We also provide a theoretical justification for the proposed family of contracts by demonstrating that they yield first-best outcomes for specific parameter choices.
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- Andrea Ferrero & Mark Gertler & Lars E. O. Svensson, 2007.
"Current Account Dynamics and Monetary Policy,"
NBER Chapters,in: International Dimensions of Monetary Policy, pages 199-244
National Bureau of Economic Research, Inc.
- Mark Gertler & Lars Svensson & Andrea Ferrero, 2008. "Current Account Dynamics and Monetary Policy," 2008 Meeting Papers 359, Society for Economic Dynamics.
- Andrea Ferrero & Mark Gertler & Lars E.O. Svensson, 2008. "Current Account Dynamics and Monetary Policy," NBER Working Papers 13906, National Bureau of Economic Research, Inc.
- Andrea Ferrero & Mark Gertler & Lars E. O. Svensson, 2008. "Current account dynamics and monetary policy," Working Paper Series 2008-26, Federal Reserve Bank of San Francisco.
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- Pierpaolo Benigno, 2008. "Price stability with imperfect financial integration," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
- Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers 2854, C.E.P.R. Discussion Papers.
- Alejandro Justiniano & Bruce Preston, 2010. "Monetary policy and uncertainty in an empirical small open-economy model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 93-128.
- Alejandro Justiniano & Bruce Preston, 2009. "Monetary policy and uncertainty in an empirical small open economy model," Working Paper Series WP-09-21, Federal Reserve Bank of Chicago.
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