Working Paper: NBER ID: w26397
Authors: Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
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.
Keywords: government policies; financial stability; borrowing constraints; optimal policy; macrofinancial stability
JEL Codes: E61; F38; F41; G01; G18; H23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policy tools (L52) | higher welfare (I31) |
| tax on tradable consumption (H29) | efficient resource allocation (D61) |
| borrowing constraint binds (D10) | tax on tradable consumption mitigates pecuniary externalities (D62) |
| tax scheme (H26) | restore efficiency (D61) |
| Ramsey optimal policy approach (H21) | welfare gains (D69) |
| policy decisions (D78) | economic environment (P42) |
| policy instruments (L52) | market price of collateral (G19) |