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Macroeconomic implications of financial policy

Author

Listed:
  • Yann Algan

    (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CEPREMAP - Centre pour la recherche économique et ses applications - ECO ENS-PSL - Département d'économie de l'ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres)

  • Olivier Allais

    (CORELA - Laboratoire de Recherche sur la Consommation - INRA - Institut National de la Recherche Agronomique, ALISS - Alimentation et sciences sociales - INRA - Institut National de la Recherche Agronomique)

  • Eva Carceles-Poveda

    (SUNY - State University of New York)

Abstract

This paper studies the effects of financial policy in a model with heterogeneous agents, incomplete markets and portfolio restrictions. For an economy calibrated to replicate key aspects of the U.S. wealth distribution, we find that the quantitative effects of financial policy are relatively small. The reason is that the households determining aggregate behavior are relatively well insured and can therefore offset the actions of the firm by modifying their portfolio allocations. However, financial policy has important effects on asset prices. Whereas a higher level of debt in the capital structure of the firm introduces more risk into the economy by increasing the volatility of the equity return, it enhances the liquidity of households by increasing the supply of bonds. In an economy with a substantial amount of heterogeneity, this last effect dominates and leverage leads to a decrease in the equity premium. This is in contrast to the findings in representative agent models, in which leverage unambiguously increases the premium through a higher equity return volatility.

Suggested Citation

  • Yann Algan & Olivier Allais & Eva Carceles-Poveda, 2009. "Macroeconomic implications of financial policy," SciencePo Working papers Main hal-03596477, HAL.
    • Handle: RePEc:hal:spmain:hal-03596477
    DOI: 10.1016/j.red.2009.02.001
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    Cited by:

    1. Atesagaoglu, Orhan Erem & Carceles-Poveda, Eva, 2015. "On the irrelevance of financial policy under market incompleteness and trading constraints," Economics Letters, Elsevier, vol. 136(C), pages 125-128.

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