Optimal Loan Loss Provisions and Welfare

Tayler, William J. and Zilberman, Roy (2021) Optimal Loan Loss Provisions and Welfare. Journal of Macroeconomics, 69: 103338. ISSN 0164-0704

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We study the welfare implications of optimal loan loss provisions in a New Keynesian model featuring endogenous default risk and inflationary credit spreads. A unique link between provisions, credit spreads and inflation can be employed to enhance macroeconomic stability. Optimal provisions are most effective when dealing with cost-push financial shocks inherent in volatile spreads and the zero bound problem of monetary policy. Relaxing provisioning requirements following a recessionary financial disturbance consistently achieves the first-best outcome while nullifying the value of monetary policy under commitment. In contrast, deflationary demand shocks warrant an optimal rise in provisions, which inflate prices yet mildly contract output.

Item Type:
Journal Article
Journal or Publication Title:
Journal of Macroeconomics
Additional Information:
This is the author’s version of a work that was accepted for publication in Journal of Macroeconomics. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Macroeconomics, 69, 2021 DOI: 10.1016/j.jmacro.2021.103338
Uncontrolled Keywords:
?? optimal provisioning policiesprudential policiescredit cost channelzero lower boundwelfareeconomics, econometrics and finance(all)economics and econometricse32e44e58g28 ??
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Deposited On:
21 Jul 2021 14:30
Last Modified:
08 May 2024 00:11