Optimal Loan Loss Provisions and Welfare

William J. Tayler and Roy Zilberman

Journal of Macroeconomics, 2021, vol. 69, issue C

Abstract: We study the welfare implications of optimal loan loss provisions in a New Keynesian model featuring endogenous default risk and inflationary credit spreads. A unique link between provisions, credit spreads and inflation can be employed to enhance macroeconomic stability. Optimal provisions are most effective when dealing with cost-push financial shocks inherent in volatile spreads and the zero bound problem of monetary policy. Relaxing provisioning requirements following a recessionary financial disturbance consistently achieves the first-best outcome while nullifying the value of monetary policy under commitment. In contrast, deflationary demand shocks warrant an optimal rise in provisions, which inflate prices yet mildly contract output.

Keywords: optimal provisioning policies; prudential policies; credit cost channel; zero lower bound; welfare (search for similar items in EconPapers)
JEL-codes: E32 E44 E58 G28 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:69:y:2021:i:c:s0164070421000434

DOI: 10.1016/j.jmacro.2021.103338

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