Privately optimal contracts and suboptimal outcomes in a model of agency costs
Abstract: This paper derives the privately optimal lending contract in the celebrated financial accelerator model of Bernanke, Gertler and Gilchrist (1999). The privately optimal contract includes indexation to the aggregate return on capital, household consumption, and the return to internal funds. Although privately optimal, this contract is not welfare maximizing as it leads to a sub-optimally high price of capital. The welfare cost of the privately optimal contract (when compared to the planner outcome) is significant. A menu of time-varying taxes and subsidies can decentralize the planner?s allocations.
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Description: Full text
Provider: Federal Reserve Bank of Cleveland
Part of Series: Working Papers (Old Series)
Publication Date: 2013-10-01
Pages: 40 pages