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 there exists at least one set of tools that implement the constrained efficient allocation that can also be used by a Ramsey planner to replicate an unconstrained allocation, achieving higher welfare. Constrained efficiency may lead to inaccurate characterizations of welfare-maximizing policies relative to Ramsey optimal policy.

Keywords: Constrained efficiency, Financial crises, Macroprudential policies and capital controls, Pecuniary externalities, Ramsey optimal policy, Social planner

JEL Classification: E61, F38, F44, H23