Optimal Time-Consistent Macroprudential Policy

Authors

Javier Bianchi, Federal Reserve Bank of Minneapolis and National Bureau of Economic Research
Enrique G. Mendoza, University of Pennsylvania, National Bureau of Economic Research, and Penn Institute for Economic Research

Date of this Version

2018

Citation

Journal of Political Economy, 2018, vol. 126, no. 2

Comments

© 2018 by The University of Chicago.

This document is a U.S. government work and is not subject to copyright in the United States.

Abstract

Collateral constraints widely used in models of financial crises feature a pecuniary externality: Agents do not internalize how borrowing decisions made in “good times” affect collateral prices during a crisis. We show that under commitment the optimal financial regulator’s plans are time inconsistent and study time-consistent policy. Quantitatively, this policy reduces sharply the frequency and magnitude of crises, removes fat tails from the distribution of asset 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 time-consistent policy.