NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Optimal Development Policies with Financial Frictions

Oleg Itskhoki, Benjamin Moll

NBER Working Paper No. 19994
Issued in March 2014
NBER Program(s):   DEV   EFG   IFM

We study optimal dynamic Ramsey policies in a standard growth model with financial frictions. For developing countries with low financial wealth, the optimal policy intervention increases labor supply and lowers wages, resulting in higher entrepreneurial profits and faster wealth accumulation. This in turn relaxes borrowing constraints in the future, leading to higher labor productivity and wages. The use of additional policy instruments, such as subsidized credit, may be optimal as well. In the long run, the optimal policy reverses sign. Taking advantage of the tractability of our framework, we extend the model to study its implications for optimal exchange rate and sectoral industrial policies.

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Document Object Identifier (DOI): 10.3386/w19994

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