Quest for Robust Optimal Macroprudential Policy

This paper contributes by providing a new approach to study optimal macroprudential policies based on economy wide welfare. Following Gerba (2017), we pin down a welfare function based on a first-and second order approximation of the aggregate utility in the economy and use it to determine the merits of different macroprudential rules for Euro Area. With the aim to test this framework, we apply it to the model of Clerc et al. (2015). We find that the optimal level of capital is 15.6 percent, or 2.4 percentage points higher tan the 2001-2015 value. Optimal capital reduces significantly the volatility of the economy while increasing somewhat the total level of welfare in steady state, even with a time-invariant instrument. Expressed differently, bank default rates would have been 3.5 percentage points lower while credit and GDP 5% and 0.8% higher had optimal capital level been in place during the 2011-2013 crisis. Further, using a model-consistent loss function, we find that the optimal Countercyclical Capital Buffer (CCyB) rule depends on whether observed or optimal capital levels are already in place. Conditional on optimal capital level, optimal CCyB rule should respond to movements in total credit and mortgage lending spreads. Gains in welfare from optimal combination of instruments is higher than the sum of their individual effects due to synergies and positive mutual spillovers.