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The Optimal Tradeoff Between Consumption Smoothing and Macroprudential Regulation

Author

Listed:
  • Jean-Paul L'Huillier

    (Einaudi Institute for Economics and Finance)

  • Facundo Piguillem

    (EIEF)

  • Jean Flemming

    (University of Rome, Tor Vergata)

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.

Suggested Citation

  • Jean-Paul L'Huillier & Facundo Piguillem & Jean Flemming, 2015. "The Optimal Tradeoff Between Consumption Smoothing and Macroprudential Regulation," 2015 Meeting Papers 492, Society for Economic Dynamics.
    • Handle: RePEc:red:sed015:492
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    References listed on IDEAS

    as
    1. Stephanie Schmitt‐Grohé & Martín Uribe, 2012. "What's News in Business Cycles," Econometrica, Econometric Society, vol. 80(6), pages 2733-2764, November.
    2. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
    3. Olivier J. Blanchard & Jean-Paul L'Huillier & Guido Lorenzoni, 2013. "News, Noise, and Fluctuations: An Empirical Exploration," American Economic Review, American Economic Association, vol. 103(7), pages 3045-3070, December.
    4. Paul Beaudry & Franck Portier, 2006. "Stock Prices, News, and Economic Fluctuations," American Economic Review, American Economic Association, vol. 96(4), pages 1293-1307, September.
    5. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
    6. Unknown, 1986. "Letters," Choices: The Magazine of Food, Farm, and Resource Issues, Agricultural and Applied Economics Association, vol. 1(4), pages 1-9.
    7. Benigno , Gianluca & Chen , Huigang & Otrock , Christopher & Rebucci , Alessandro & Young , Eric R., 2012. "Monetary and Macro-prudential Policies: An Integrated Analysis," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 7(1), pages 1-40, October.
    8. Enrique G. Mendoza, 2002. "Credit, Prices, and Crashes: Business Cycles with a Sudden Stop," NBER Chapters, in: Preventing Currency Crises in Emerging Markets, pages 335-392, National Bureau of Economic Research, Inc.
    9. Sebastian Edwards & Jeffrey A. Frankel, 2002. "Preventing Currency Crises in Emerging Markets," NBER Books, National Bureau of Economic Research, Inc, number edwa02-2, May.
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    Cited by:

    1. Javier Bianchi & Chenxin Liu & Enrique G. Mendoza, 2016. "Fundamentals News, Global Liquidity, and Macroprudential Policy," NBER Chapters, in: NBER International Seminar on Macroeconomics 2015, National Bureau of Economic Research, Inc.

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