Optimal Time-Consistent Macroprudential Policy

80 Pages Posted: 8 Oct 2015

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: October 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 (October 2015). BIS Working Paper No. 516, Available at SSRN: https://ssrn.com/abstract=2670111

Javier Bianchi (Contact Author)

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

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Enrique G. Mendoza

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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