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The Financial Accelerator and the Optimal Lending Contract

Mikhail Dmitriev and Jonathan Hoddenbagh ()

2013 Papers from Job Market Papers

Abstract: In the financial accelerator literature pioneered by Bernanke, Gertler and Gilchrist (1999) entrepreneurs are myopic and lenders suboptimally choose a safe rate of return on their loans. We derive the optimal lending contract for forward looking entrepreneurs and provide three main results. First, under the optimal contract we find that financial frictions do not amplify business cycle fluctuations. Second, we show that shocks to the variance of unobserved idiosyncratic productivity --- so-called ``risk shocks'' --- have little effect on the real economy under the optimal contract. Third, we find that amplification under the suboptimal contract depends on loose monetary policy: when interest rate setting follows a standard Taylor rule, the financial accelerator is significantly dampened or even reversed.

JEL-codes: E3 (search for similar items in EconPapers)
Date: 2013-11-14
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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