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Prudential policy with distorted beliefs

Eduardo Davila and Ansgar Walther

No 130, ESRB Working Paper Series from European Systemic Risk Board

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 Classification: G28, G21, E61, E52

Keywords: bailouts; distorted beliefs; leverage regulation; monetary policy; prudential policy (search for similar items in EconPapers)
Date: 2021-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-mac and nep-mon
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Related works:
Working Paper: Prudential Policy with Distorted Beliefs (2021) Downloads
Working Paper: Prudential Policy with Distorted Beliefs (2021) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:srk:srkwps:2021130

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