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This morning, you can choke on your cereal watching this...
http://conference.nber.org/sched/SI20EFBEM
http://conference.nber.org/sched/SI20EFBEM
Non-rational expectations, yes.
Overconfidence, hell yeah!
As usual you can find the streams here
https://www.nber.org/si2020livestream/
or if that is down just go to the NBER channel on youtube and search for it.
Overconfidence, hell yeah!
As usual you can find the streams here
https://www.nber.org/si2020livestream/
or if that is down just go to the NBER channel on youtube and search for it.
short thread to give the gist of itFirst, what is Macroprudential policy? I like to use this chart. Financial decisions in good times have an impact later.
So we should regulate them right? Yes, but not so fast.
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To us, to the bottom of it, you must answer two questions...
1. can't monetary policy solve the problem ex-post?
2. what's the externality?
To 1: no it cannot, for example: zero lower bound (there are other possibilities such as currency union within Euro, and other reasons)
1. can't monetary policy solve the problem ex-post?
2. what's the externality?
To 1: no it cannot, for example: zero lower bound (there are other possibilities such as currency union within Euro, and other reasons)
For 2: many financial decisions I make may hurt me later, e.g. I took a risk and it turned out bad, that is sad ex post but in itself doesn't necessarily mean you should regulate. But we isolate an aggregate externality, which implies you do want to regulate.
Up to here these concepts and ideas are based on some past formalizations of ours "A Theory of Macroprudential Policies..." https://dspace.mit.edu/bitstream/handle/1721.1/114273/w19313.pdf?sequence=1&isAllowed=y
What we do new here...
1. we study a model with risk and risk premia
2. we allow for non-rational expectations, with irrational exhuberance that gets popped at a "Minsky moment"
We want to talk to this important policy debate:
1. we study a model with risk and risk premia
2. we allow for non-rational expectations, with irrational exhuberance that gets popped at a "Minsky moment"
We want to talk to this important policy debate:
Following a finance literature we use "extrapolative expectations": when asset prices rise, their owners get optimistic and borrow more to buy the asset, fueling the rise in its price. This sets the stage for a painful "Minsky Moment"
The question is what to do before that?
The question is what to do before that?
This table summarizes the results we get. With some caveats, we find that if you have rational expectations, then you should use macroprudential policy, but monetary policy should not lean against the wind (first row).
Add in extrapolative expectations and the picture changes...
Add in extrapolative expectations and the picture changes...
Ideally, with macropru policy: take care of the excess borrowing with that. Monetary policy targets unchanged (bottom right) but might have to be more aggressive on rates.
But limited macropru (bottom left) the picture changes more: now monetary policy should lean against wind.
But limited macropru (bottom left) the picture changes more: now monetary policy should lean against wind.
That is, monetary policy cools down the economy, cooling off asset prices, reducing the borrowing.
In practice, I think we are somewhere between bottom left and bottom right. Macropru never goes all the way. As Stein put it "monetary policy fills all the cracks"
In practice, I think we are somewhere between bottom left and bottom right. Macropru never goes all the way. As Stein put it "monetary policy fills all the cracks"
We've had this paper in the works for ~3 years, kept tinkering with it, looking for the right message. Initially, we just had risk and the top row.
But we feel that a real-world concern is the kind of dynamics of overconfidence, often left out of academic work.
But we feel that a real-world concern is the kind of dynamics of overconfidence, often left out of academic work.
(not all work, we mention a few and welcome more references here)
Anyway, maybe we're wrong, but worth exploring, I think!
Anyway, maybe we're wrong, but worth exploring, I think!
And that's it for now.
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