Macroprudential policy with earnings-based borrowing constraints

A large literature has studied optimal regulatory policy in macroeconomic models with asset-based collateral constraints. A common conclusion is that agents ‘over-borrow’ and optimal policy reduces debt positions through taxes. The reason is that agents do not internalize the effects of their choices on asset prices. However, recent empirical evidence shows that firms primarily borrow against their earnings rather than their assets. This paper studies optimal macroprudential policy with earnings-based borrowing constraints, both in closed and open economies. We reach the opposite conclusion to the previous literature. Agents ‘over-save’ (and ‘under-borrow’) relative to the social optimum, as they do not internalize changes in wages, which in turn affect firms’ earnings. A numerical model exercise demonstrates that incorrectly rolling out a tax policy derived under the assumption of asset-based constraints in an economy where firms actually borrow based on earnings leads to a consumption equivalent welfare loss of up to 2.55%. Optimal macroprudential policy thus critically depends on the specific form of financial constraints.