Macroprudential policymakers with cautious expectations

Abstract

We introduce cautious expectations to a macroprudential policy model where average growth is traded off against growth-at-risk (GaR). Policymakers with cautious expectations estimate the optimal weight to apply to risk signals, creating biased, historically dependent crisis forecasts. They optimally downweight the effects of risk and their policy settings on GaR forecasts, decreasing the expected efficiency of the growth-GaR trade-off. This loosens the optimal policy stance, but also causes policymakers to respond more aggressively to changing signals. As policymakers experience additional crises, they better understand the effects of their policy instruments and tighten their stance. When past crises are forgotten, this tendency reverses.