Prudential Policy with Distorted Beliefs

Eduardo Davila and Ansgar Walther

No 28879, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper studies leverage regulation and monetary policy when equity investors and/or creditors have distorted beliefs relative to a planner. We characterize how the optimal leverage regulation responds to arbitrary changes in investors' and creditors' beliefs and relate our results to practical scenarios. We show that the optimal regulation depends on the type and magnitude of such changes. Optimism by investors calls for looser leverage regulation, while optimism by creditors, or jointly by both investors and creditors, calls for tighter leverage regulation. Monetary policy should be tightened (loosened) in response to either investors' or creditors' optimism (pessimism).

JEL-codes: E52 E61 G21 G28 (search for similar items in EconPapers)
Date: 2021-06
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
Note: AP CF EFG ME
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Published as Eduardo Dávila & Ansgar Walther, 2023. "Prudential Policy with Distorted Beliefs," American Economic Review, vol 113(7), pages 1967-2006.

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Journal Article: Prudential Policy with Distorted Beliefs (2023)
Working Paper: Prudential Policy with Distorted Beliefs (2022)
Working Paper: Prudential Policy with Distorted Beliefs (2021)
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