Optimal Time-Consistent Macroprudential Policy
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.
We are grateful for the support of the National Science Foundation under awards 1325122 (Mendoza) and 1324395 (Bianchi), Mendoza also acknowledges the support of the Bank for International Settlements under a 2014 Research Fellowship and the Jacobs Levy Center for Quantitative Financial Research of the Wharton School under a 2014-15 research grant. We thank Fernando Alvarez, Gianluca Benigno, John Cochrane, Alessandro Dovis, Charles Engel, Lars Hansen, Zheng Liu, Guido Lorenzoni, and Tom Sargent for helpful comments and discussions. We also acknowledge comments by audiences at several seminar and conference presentations since 2010. Some material included here circulated earlier under the title “Overborrowing, Financial Crises and Macroprudential Policy”, NBER WP 16091, June 2010. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Javier Bianchi & Enrique G. Mendoza, 2018. "Optimal Time-Consistent Macroprudential Policy," Journal of Political Economy, vol 126(2), pages 588-634.