RegGae: a toolkit for macroprudential policy with DSGEs

Eduardo Castro

No 526, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: RegGae is a toolkit to adapt DSGE models for analyzing macroprudential policy. To be useful for macroprudential policy, a DSGE needs to have financial crises along the equilibrium path. RegGae embeds financial crises in DSGEs as regime switches, events that change the structural relationships in the economy. The solu-tion concept of RegGae is regime-wise linearization, a procedure that preserves the non-linearities of models of financial crises. The transition probabilities governing the switch are endogenous, conditional on the state variables. With the toolkit, DSGEs can be used to draw the distribution of variables in order to measure the expected welfare of macroprudential policy. This allows for calibrating macropru-dential tools to trade off mean and variance optimally. The toolkit unifies DSGE modeling with early warning (crisis prediction) methods. The endogeneity of the probability of regime switches reflects the fact that the probability of financial crises depends on the state of the economy while its timing cannot be forecasted. Because financial markets do not anticipate financial crises, RegGae assumes the typical per-fect foresight of the future sequence of regimes.

Date: 2020-07
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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