Optimal Contracts, Aggregate Risk and the Financial Accelerator

32 Pages Posted: 29 Nov 2014

See all articles by Timothy S. Fuerst

Timothy S. Fuerst

University of Notre Dame

Charles T. Carlstrom

Federal Reserve Bank of Cleveland

Matthias Paustian

Bank of England

Date Written: November 28, 2014

Abstract

This paper derives the optimal lending contract in the financial accelerator model of Bernanke, Gertler and Gilchrist (BGG). The optimal contract includes indexation to the aggregate return on capital, household consumption, and the return to internal funds. This triple indexation results in a dampening of fluctuations in leverage and the risk premium. Hence, compared to the contract originally imposed by BGG, the privately optimal contract implies essentially no financial accelerator.

Keywords: Financial accelerator, optimal contracts, aggregate risk

JEL Classification: E32, C32

Suggested Citation

Fuerst, Timothy S. and Carlstrom, Charles T. and Paustian, Matthias, Optimal Contracts, Aggregate Risk and the Financial Accelerator (November 28, 2014). Bank of England Working Paper No. 517, Available at SSRN: https://ssrn.com/abstract=2531681 or http://dx.doi.org/10.2139/ssrn.2531681

Timothy S. Fuerst

University of Notre Dame ( email )

Notre Dame, IN 46556
United States

Charles T. Carlstrom

Federal Reserve Bank of Cleveland ( email )

PO Box 6387
Cleveland, OH 44101-1387
United States
216-579-2294 (Phone)
216-579-3050 (Fax)

Matthias Paustian (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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