Piotr Zoch, University of Warsaw

We characterize governments' optimal responses to asset market disturbances across a broad class of models with financial frictions. We show that the Ramsey plan can be achieved by a policy rule targeting a specific relationship between asset returns, regardless of the underlying disturbances. This relationship is determined by asset supply and demand elasticities that can be estimated empirically with standard identification strategies. Absent financial frictions, the optimal policy stabilizes spreads across all assets. However, in the presence of financial frictions, the optimal rule prescribes time-varying spreads to facilitate financial intermediation. We apply our framework to study the optimal design of asset purchase and lending programs, as implied by key empirical estimates of asset supply and demand elasticities.

Co-author: Yu-Ting Chiang