Macroprudential policy with earnings-based borrowing constraints

Thomas Drechsel and Seho Kim

Journal of Monetary Economics, 2024, vol. 147, issue C

Abstract: A large literature has studied optimal regulatory policy in macroeconomic models with asset-based collateral constraints. A common conclusion is that agents ‘over-borrow’ and optimal policy reduces debt positions through taxes. The reason is that agents do not internalize the effects of their choices on asset prices. However, recent empirical evidence shows that firms primarily borrow against their earnings rather than their assets. This paper studies optimal macroprudential policy with earnings-based borrowing constraints, both in closed and open economies. We reach the opposite conclusion to the previous literature. Agents ‘over-save’ (and ‘under-borrow’) relative to the social optimum, as they do not internalize changes in wages, which in turn affect firms’ earnings. A numerical model exercise demonstrates that incorrectly rolling out a tax policy derived under the assumption of asset-based constraints in an economy where firms actually borrow based on earnings leads to a consumption equivalent welfare loss of up to 2.55%. Optimal macroprudential policy thus critically depends on the specific form of financial constraints.

Keywords: Financial frictions; Macroprudential policy; Collateral constraints; Earnings-based borrowing constraints; Pecuniary externalities (search for similar items in EconPapers)
JEL-codes: D62 E32 E44 G28 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: Macroprudential policy with earnings-based borrowing constraints (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:147:y:2024:i:c:s0304393224000485

DOI: 10.1016/j.jmoneco.2024.103595

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