Optimal Policy for Macro-Financial Stability
35 Pages Posted: 11 Aug 2019
Date Written: August 7, 2019
There is a recent and now large literature analyzing government policies for financial stability based on models with endogenous borrowing constraints. The normative analysis of these models builds upon the concept of constrained efficient allocation in which the social planner faces the same borrowing constraint as individual agents. In this paper, we show that the set of policy tools that implement the constrained efficient allocation can be used by a Ramsey planner to achieve higher welfare and replicate the unconstrained allocation. Thus the constrained social planner approach may lead to an inaccurate characterization of welfare-maximizing policies relative to the Ramsey approach for the same policy tool. We illustrate this point in a well-known model environment and show that the drawback of the social planner approach arises because of the policy instrument's ability to affect the collateral value in the borrowing constraint.
Keywords: Constrained efficiency, Financial crises, Macroprudential policies and capital controls, Pecuniary externalities, Ramsey optimal policy, Social planner
JEL Classification: E61, F38, F44, H23
Suggested Citation: Suggested Citation