diff --git a/diesel_cli/src/main.rs b/diesel_cli/src/main.rs
index 045248292c85..a0ae06a971a3 100644
--- a/diesel_cli/src/main.rs
+++ b/diesel_cli/src/main.rs
@@ -96,8 +96,8 @@ where
 
 #[tracing::instrument]
 fn run_setup_command(matches: &ArgMatches) -> Result<(), crate::errors::Error> {
-    create_config_file(matches)?;
     let migrations_dir = create_migrations_dir(matches)?;
+    create_config_file(matches, &migrations_dir)?;
 
     database::setup_database(matches, &migrations_dir)?;
     Ok(())
@@ -136,12 +136,22 @@ fn create_migrations_dir(matches: &ArgMatches) -> Result<PathBuf, crate::errors:
     Ok(dir)
 }
 
-fn create_config_file(matches: &ArgMatches) -> Result<(), crate::errors::Error> {
+fn create_config_file(
+    matches: &ArgMatches,
+    migrations_dir: &Path,
+) -> Result<(), crate::errors::Error> {
     use std::io::Write;
     let path = Config::file_path(matches);
     if !path.exists() {
+        let source_content = include_str!("default_files/diesel.toml").to_string();
+        // convert the path to a valid toml string (escaping backslashes on windows)
+        let migrations_dir_toml_string = migrations_dir.display().to_string().replace('\\', "\\\\");
+        let modified_content = source_content.replace(
+            "dir = \"migrations\"",
+            &format!("dir = \"{}\"", migrations_dir_toml_string),
+        );
         let mut file = fs::File::create(path)?;
-        file.write_all(include_bytes!("default_files/diesel.toml"))?;
+        file.write_all(modified_content.as_bytes())?;
     }
 
     Ok(())
@@ -183,7 +193,7 @@ fn generate_completions_command(matches: &ArgMatches) {
 /// Returns a `DatabaseError::ProjectRootNotFound` if no Cargo.toml is found.
 fn create_migrations_directory(path: &Path) -> Result<PathBuf, crate::errors::Error> {
     println!("Creating migrations directory at: {}", path.display());
-    fs::create_dir(path)?;
+    fs::create_dir_all(path)?;
     fs::File::create(path.join(".keep"))?;
     Ok(path.to_owned())
 }
diff --git a/diesel_cli/tests/database_setup.rs b/diesel_cli/tests/database_setup.rs
index ffedc1630a20..947ee706b149 100644
--- a/diesel_cli/tests/database_setup.rs
+++ b/diesel_cli/tests/database_setup.rs
@@ -152,6 +152,39 @@ fn database_setup_respects_migration_dir_by_arg() {
     assert!(db.table_exists("users"));
 }
 
+#[test]
+fn database_setup_respects_migration_nested_dir_by_arg() {
+    let p = project("database_setup_respects_migration_nested_dir_by_arg")
+        .folder("foo/bar")
+        .build();
+    let db = database(&p.database_url());
+
+    p.create_migration_in_directory(
+        "foo/bar",
+        "12345_create_users_table",
+        "CREATE TABLE users ( id INTEGER )",
+        Some("DROP TABLE users"),
+        None,
+    );
+
+    // sanity check
+    assert!(!db.exists());
+
+    let result = p
+        .command("database")
+        .arg("setup")
+        .arg("--migration-dir=foo/bar")
+        .run();
+
+    assert!(result.is_success(), "Result was unsuccessful {:?}", result);
+    assert!(
+        result.stdout().contains("Running migration 12345"),
+        "Unexpected stdout {}",
+        result.stdout()
+    );
+    assert!(db.table_exists("users"));
+}
+
 #[test]
 fn database_setup_respects_migration_dir_by_env() {
     let p = project("database_setup_respects_migration_dir_by_env")
diff --git a/diesel_cli/tests/setup.rs b/diesel_cli/tests/setup.rs
index d0bab07b5b17..a65a0d39ff28 100644
--- a/diesel_cli/tests/setup.rs
+++ b/diesel_cli/tests/setup.rs
@@ -170,6 +170,41 @@ fn setup_works_with_migration_dir_by_arg() {
     assert!(p.has_file("foo"));
 }
 
+#[test]
+fn setup_writes_migration_dir_by_arg_to_config_file() {
+    let p = project("setup_writes_migration_dir_by_arg_to_config_file").build();
+
+    // make sure the project builder doesn't create it for us
+    assert!(!p.has_file("migrations"));
+    assert!(!p.has_file("foo"));
+
+    let result = p.command("setup").arg("--migration-dir=foo").run();
+
+    assert!(result.is_success(), "Result was unsuccessful {:?}", result);
+    assert!(!p.has_file("migrations"));
+    assert!(p.has_file("foo"));
+    assert!(p.file_contents("diesel.toml").contains("dir = \"foo\""));
+}
+
+#[test]
+#[cfg(windows)]
+fn setup_writes_migration_dir_by_arg_to_config_file_win() {
+    let p = project("setup_writes_migration_dir_by_arg_to_config_file_win").build();
+
+    // make sure the project builder doesn't create it for us
+    assert!(!p.has_file("migrations"));
+    assert!(!p.has_file("foo"));
+
+    let result = p.command("setup").arg("--migration-dir=foo\\bar").run();
+
+    assert!(result.is_success(), "Result was unsuccessful {:?}", result);
+    assert!(!p.has_file("migrations"));
+    assert!(p.has_file("foo"));
+    assert!(p
+        .file_contents("diesel.toml")
+        .contains("dir = \"foo\\\\bar\""));
+}
+
 #[test]
 fn setup_works_with_migration_dir_by_env() {
     let p = project("setup_works_with_migration_dir_by_env").build();
diff --git a/diesel_cli/tests/support/project_builder.rs b/diesel_cli/tests/support/project_builder.rs
index c1199b1aba17..5110e409c599 100644
--- a/diesel_cli/tests/support/project_builder.rs
+++ b/diesel_cli/tests/support/project_builder.rs
@@ -45,7 +45,7 @@ impl ProjectBuilder {
         File::create(tempdir.path().join("Cargo.toml")).unwrap();
 
         for folder in self.folders {
-            fs::create_dir(tempdir.path().join(folder)).unwrap();
+            fs::create_dir_all(tempdir.path().join(folder)).unwrap();
         }
 
         for (file, contents) in self.files {