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Optimal Time-Consistent Macroprudential Policy Revisited (find latest version here)

Abstract: This paper studies optimal time-consistent macroprudential policy in a model with endogenous capital formation. Previous studies assumed that aggregate capital is fixed or absent. Consistent with these studies, I find that it is optimal to restrict borrowing ex ante and to support it in times of financial stress. However, macroprudential regulation tends to reduce capital formation, such that optimal regulation is less interventionist than under fixed or no capital. Optimal macroprudential policy hardly prevents crises and the induced welfare gains are minimal. When investment policy is added, crises are almost nonexistent and welfare gains are substantially higher.