Working Paper: NBER ID: w19994
Authors: Oleg Itskhoki; Benjamin Moll
Abstract: We study optimal dynamic Ramsey policies in a standard growth model with financial frictions. For developing countries with low financial wealth, the optimal policy intervention increases labor supply and lowers wages, resulting in higher entrepreneurial profits and faster wealth accumulation. This in turn relaxes borrowing constraints in the future, leading to higher labor productivity and wages. The use of additional policy instruments, such as subsidized credit, may be optimal as well. In the long run, the optimal policy reverses sign. Taking advantage of the tractability of our framework, we extend the model to study its implications for optimal exchange rate and sectoral industrial policies.
Keywords: Optimal policy; Financial frictions; Economic development; Ramsey policies
JEL Codes: E60; F40; O0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal policy interventions (D78) | increased labor supply (J20) |
| optimal policy interventions (D78) | decreased wages (J31) |
| increased labor supply (J20) | higher entrepreneurial profits (P12) |
| higher entrepreneurial profits (P12) | faster wealth accumulation (G51) |
| faster wealth accumulation (G51) | relaxed borrowing constraints (G51) |
| relaxed borrowing constraints (G51) | improved labor productivity (J24) |
| improved labor productivity (J24) | higher wages (J39) |
| increased labor supply (J20) | faster wealth accumulation (G51) |
| optimal policy interventions (D78) | higher labor productivity (J24) |