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The Optimal Tradeoff Between Consumption Smoothing and Macroprudential Regulation

Jean-Paul L'Huillier, Facundo Piguillem and Jean Flemming ()
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Jean-Paul L'Huillier: Einaudi Institute for Economics and Finance
Facundo Piguillem: EIEF

No 492, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: We study the optimal determination of macroprudential regulation (Mendoza 2002, Bianchi 2011, Korinek 2014) in a macroeconomic model featuring advance information about future income ("news", cf. Beaudry and Portier 2006, or Schmitt-Grohe and Uribe 2012). We point out that the presence of news about the future in a standard model with systemic externalities introduces a tradeoff between consumption smoothing and macroprudential regulation. Indeed, favorable news call for lax regulation in order to allow for consumption smoothing, but this also increases the severity of welfare losses in systemic crises. We study this tradeoff first theoretically in a simple 3-period model, and then quantitatively in a fully dynamic model. We conclude that the possibility of news is an important consideration in the evaluation and of macroprudential regulation.

Date: 2015
New Economics Papers: this item is included in nep-cba, nep-dge and nep-opm
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