Optimal Policy for Macro-Financial Stability

Abstract: There is a new and now large literature analyzing government policies for financial stability based on models with endogenous borrowing constraints. These normative analyses build upon the concept of constrained efficient allocation, where the social planner is constrained by the same borrowing limit that agents face. In this paper, we show that the same set of policy tools that implement the constrained efficient allocation can be used by a Ramsey planner to replicate the unconstrained allocation, thus achieving higher welfare. The constrained social planner approach may lead to inaccurate characterizations of welfare-maximizing policies relative to the Ramsey approach.

Keywords: Ramsey optimal policy; social planner; constrained efficiency; financial crises; pecuniary externalities; macroprudential policies and capital controls;

JEL Classification: E61; H23; F44; F38;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2019-10-01

Number: 899

Pages: 26 pages