Optimal Policy for Macro-Financial Stability

Abstract

In this paper we study whether policy makers should wait to intervene until a financial crisis strikes or rather act in a preemptive manner. We study this question in a relatively simple dynamic stochastic general equilibrium model in which crises are endogenous events induced by the presence of an occasionally binding borrowing constraint as in Mendoza (2010). First, we show that the same set of taxes that replicates the constrained social planner allocation could be used optimally by a Ramsey planner to achieve the first best unconstrained equilibrium: in both cases without any precautionary intervention. Second, we show that the extent to which policymakers should intervene in a preemptive manner depends critically on the set of policy tools available and what these instruments can achieve when a crisis strikes. For example, in the context of our model, we find that, if the policy tools is constrained so that the first best cannot be achieved and the policy make r has access to only one tax instrument, it is always desirable to intervene before the crisis regardless of the instrument used. If however the policy maker has access to two instruments, it is optimal to act only during crisis times. Third and finally, we propose a computational algorithm to solve Markov-Perfect optimal policy for problems in which the policy function is not differentiable.

Optimal Capital Controls and Real Exchange Rate Policies: A Pecuniary Externality Perspective

“…As we shall see below, two of the government policy instruments that we consider, when used optimally, can completely remove the e¤ects of the constraint (4) and achieve an allocation that is identical to the competitive equilibrium of the model without the borrowing constraint (4). In what follows we refer to this allocation as the "unconstrained equilibrium" (UE) and we characterize it in the online appendix.…”

“…The tax on foreign debt is usually interpreted as a capital control, while taxes on either tradable or nontradable consumption can be interpreted as a real exchange rate interventions because they a¤ect directly the relative price of nontradables. 4 4 The interpretation of the relative price of nontradables as the real exchange rate is standard in the 2…”

“…More generally, our study of alternative policy tools is related to the work by Correia, Nicolini and Teles (2008) in which the role of price stickiness for the design of monetary policy depends on the existence of alternative …scal policy tools. Finally, in terms of the solution techniques, we apply the same algorithm proposed by Benigno et al (2012) to solve numerically for the Markov Perfect optimal policy problem in the context of a production version of our economy in which a time-consistency issue arises.…”

Integration of Financial Markets in Post Global Financial Crises and Implications for British Financial Sector: Analysis Based on A Panel VAR Model

“…There is also emphasis on the policy measures whether macroeconomic policy measure supported by Williams (2012), Blanchard et al (2010) Mishkin (2011) and Nasir and Soliman (2014) or studies for instance by Angelini et al (2012) Benigno et al (2012) Mishkin (2011) which support the idea of prudential policies. However, the policy debate is infinitely perpetual as there are also arguments against the role of macroeconomic and prudential policies in the stable functioning of financial markets (See Benigno et al 2013Agenor et al (2011 and Borio (2011), Svensson (2012) and Collard et al (2012).…”

Good News Is Bad News: Leverage Cycles and Sudden Stops

“…This paper explicitly models banks' ex-ante equity issuance behavior and shows that it plays an important role in generating the frequency and depth of banking crises ex-post. Other related papers include Uribe and Yue (2006); Bianchi and Mendoza (2010);Bianchi (2011);Benigno et al (2012); Otrok et al (2012), and Bianchi and Mendoza (2013).…”