Optimal credit market policy

Abstract

We study optimal credit market policy in a stochastic, quantitative, general equilibrium, infinite-horizon economy with collateral constraints tied to housing prices. Collateral constraints imply that the competitive equilibrium is Pareto inefficient. Taxing housing or borrowing in good states and subsidizing it in recessions leads to a Pareto-improving allocation for borrowers and savers. Quantitatively, the welfare gains afforded by the optimal tax are significant. The optimal tax reduces the covariance of house prices with consumption, and, by doing so, it increases house prices on average and delivers welfare gains both in steady state and around it. We also show that the welfare gains stem from mopping up after the crash rather than the ex-ante macroprudential aspect, aligning with prior research that emphasizes the importance of ex-post measures compared to preventive policies alone.