Robust Optimal Macroprudential Policy

IMF Working Papers, February 26, 2021

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The paper analyzes how fear of model misspecification by the planner and/or households affects welfare gains from optimal macroprudential taxes.
The setting is an economy with occasionally binding collateral constraints as in Bianchi (2011).
Robust policy is interpreted in the Hansen and Sargent (2011) sense: policies that are optimal under a "worst-case" model of shocks.

There exist welfare gains from internalizing how borrowing decisions in good times affect the value of collateral during a crisis.
A planner who designs policy to be robust to model misspecification can produce negligible welfare gains, or even welfare losses, if the planner's worst-case model is far from the true underlying distribution of shocks.
A robust planner introduces taxes that are 5 percentage points higher but does not achieve a significant increase in welfare gains compared to a non-robust planner when the true underlying model is not the worst-case.
If households also make choices that are robust to model misspecification, welfare gains are significantly reduced.
A highly-robust planner, when households behave robustly, can "underborrow" and induce welfare losses.
If the worst-case scenario assumed by the robust planner is realized, welfare gains are the largest possible.

Internalizing the impact of good-time borrowing on crisis-period collateral values can yield welfare improvements.
Designing macroprudential taxes under model uncertainty requires careful assessment of how far the planner's perceived worst-case deviates from plausible true distributions; excessive robustness can be counterproductive.
Policymakers should consider the interaction between planner robustness and household robustness: when households are themselves robust in choices, planner robustness may need to be calibrated downward to avoid underborrowing and welfare losses.

Non-worst-case true model: Robust planner raises taxes by 5 percentage points but gains are negligible relative to non-robust planner.
Households robust and planner highly robust: Interaction can produce underborrowing and welfare losses.
Worst-case realized: Robust planner attains the largest possible welfare gains.

Source: Robust Optimal Macroprudential Policy, Giselle Montamat and Francisco Roch.