Optimal Policy for Macro-Financial Stability

27 Pages Posted: 30 Oct 2019

See all articles by Gianluca Benigno

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics

Huigang Chen

MarketShare Partners

Chris Otrok

University of Missouri; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Eric R. Young

University of Virginia

Multiple version iconThere are 6 versions of this paper

Date Written: October 2019

Abstract

There is a new and now extensive literature analyzing government policies for financial stability based on models with endogenous borrowing constraints. These normative analyses often 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 optimally by a Ramsey planner to replicate the unconstrained allocation, thus achieving higher welfare. We establish this in the context of a well-known model economy, but the result is relevant whenever the policy instrument that is assigned to the planner can affect the market price that determines the value of collateral in the borrowing constraint. The result implies that a robust normative analysis in this model class requires explicit computations of the Ramsey optimal policy problem.

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Suggested Citation

Benigno, Gianluca and Chen, Huigang and Otrok, Christopher and Rebucci, Alessandro and Young, Eric R., Optimal Policy for Macro-Financial Stability (October 2019). NBER Working Paper No. w26397. Available at SSRN: https://ssrn.com/abstract=3476477

Gianluca Benigno (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

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Huigang Chen

MarketShare Partners ( email )

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Christopher Otrok

University of Missouri ( email )

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Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Eric R. Young

University of Virginia ( email )

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