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

Charles Carlstrom, Timothy Fuerst and Matthias Paustian
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Matthias Paustian: https://www.federalreserve.gov/econres/matthias-o-paustian.htm

No 1204, Working Papers (Old Series) from Federal Reserve Bank of Cleveland

Abstract: 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

Keywords: Contracts; Financial markets (search for similar items in EconPapers)
Pages: 33 pages
Date: 2012
New Economics Papers: this item is included in nep-bec and nep-dge
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Citations: View citations in EconPapers (1)

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https://doi.org/10.26509/frbc-wp-201204 Persistent link
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Related works:
Working Paper: Privately optimal contracts and suboptimal outcomes in a model of agency costs (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedcwp:1204

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DOI: 10.26509/frbc-wp-201204

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