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A Theory of Macroprudential Policies in the Presence of Nominal Rigidities

  • Emmanuel Farhi
  • Iván Werning

We provide a unifying foundation for macroprudential policies in financial markets for economies with nominal rigidities in goods and labor markets. Interventions are beneficial because of an aggregate demand externality. Ex post, the distribution of wealth across agents affect aggregate demand and the efficiency of equilibrium through Keynesian channels. However, ex ante, these effects are not privately internalized in the financial decisions agents make. We obtain a formula that characterizes the size and direction for optimal financial market interventions. We provide a number of applications of our general theory, including macroprudential policies guarding against deleveraging and liquidity traps, capital controls due to fixed exchange rates or liquidity traps and fiscal transfers within a currency union. Finally, we show how our results are also relevant for redistributive or social insurance policies, such as income taxes or unemployment benefits, allowing one to incorporate the macroeconomic benefits associated with these policies.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19313.

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Date of creation: Aug 2013
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Handle: RePEc:nbr:nberwo:19313
Note: EFG ME
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  1. M. L. Weitzman, 1973. "Prices vs. Quantities," Working papers 106, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
  3. John Geanakoplos & Michael Magill & Martine Quinzii & J. Dreze, 1988. "Generic Inefficiency of Stock Market Equilibrium When Markets Are Incomplete," Cowles Foundation Discussion Papers 863, Cowles Foundation for Research in Economics, Yale University.
  4. Guido Lorenzoni & Veronica Guerrieri, 2011. "Credit Crises, Precautionary Savings and the Liquidity Trap," 2011 Meeting Papers 1414, Society for Economic Dynamics.
  5. 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.
  6. Anton Korinek, 2011. "The New Economics of Prudential Capital Controls: A Research Agenda," IMF Economic Review, Palgrave Macmillan, vol. 59(3), pages 523-561, August.
  7. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," Working Paper Series WP10-5, Peterson Institute for International Economics.
  8. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
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