Staff Working Paper No. 517
Timothy S Fuerst, Charles T Carlstrom and Matthias Paustian
This paper derives the optimal lending contract in the financial accelerator model of Bernanke, Gertler and Gilchrist (BGG). The optimal contract includes indexation to the aggregate return on capital, household consumption, and the return to internal funds. This triple indexation results in a dampening of fluctuations in leverage and the risk premium. Hence, compared to the contract originally imposed by BGG, the privately optimal contract implies essentially no financial accelerator.