Optimal Time-Consistent Macroprudential Policy

77 Pages Posted: 15 Sep 2015 Last revised: 18 Sep 2020

See all articles by Javier Bianchi

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Multiple version iconThere are 3 versions of this paper

Date Written: August 1, 2015

Abstract

Collateral constraints widely used in models of financial crises feature a pecuniary externality: Agents do not internalize how borrowing decisions taken in "good times" affect collateral prices during a crisis. We show that agents in a competitive equilibrium borrow more than a financial regulator who internalizes this externality. We also find, however, that under commitment the regulator's plans are time-inconsistent, and hence focus on studying optimal, time-consistent policy without commitment. This policy features a state-contingent macroprudential debt tax that is strictly positive at date t if a crisis has positive probability at t + 1. Quantitatively, this policy reduces sharply the frequency and magnitude of crises, removes fat tails from the distribution of returns, and increases social welfare. In contrast, constant debt taxes are ineffective and can be welfare-reducing, while an optimized "macroprudential Taylor rule" is effective but less so than the optimal policy.

Keywords: Financial crises, macroprudential policy, systemic risk, collateral constraints

JEL Classification: D62, E32, E44, F32, F41

Suggested Citation

Bianchi, Javier and Mendoza, Enrique G., Optimal Time-Consistent Macroprudential Policy (August 1, 2015). PIER Working Paper No. 15-032, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=2660302 or http://dx.doi.org/10.2139/ssrn.2660302

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Enrique G. Mendoza (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

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