Privately Optimal Contracts and Suboptimal Outcomes in a Model of Agency Costs
33 Pages Posted: 31 Jan 2012
There are 2 versions of this paper
Optimal Contracts, Aggregate Risk, and the Financial Accelerator
Date Written: January 27, 2012
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 and household consumption. Although privately optimal, this contract is not welfare maximizing as it exacerbates fluctuations in real activity. The household’s desire to hedge business cycle risk, leads, via the financial contract, to greater business cycle risk. The welfare cost of the privately optimal contract (when compared to the planner outcome) is quite large. A countercyclical tax on lender profits comes close to achieving the planner outcome.
Keywords: Agency costs, CGE models, optimal contracting
JEL Classification: C68, E44, E61
Suggested Citation: Suggested Citation
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