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Overborrowing, financial crises and ‘macro-prudential’ taxes

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  • Enrique Mendoza
  • Javier Bianchi

Abstract

We study overborrowing and financial crises in an equilibrium model of business cycles and asset prices with collateral constraints. Private agents in a decentralized competitive equilibrium do not internalize the effects of their individual borrowing plans on the market price of assets at which collateral is valued and on the wage costs relevant for working capital financing. Compared with a constrained social planner who internalizes these effects, they undervalue the benefits of an increase in net worth when the constraint binds and hence they borrow "too much" ex ante. Quantitatively, average debt and leverage ratios are only slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises is much larger. Excess asset returns, Sharpe ratios and the market price of risk are also much larger. A state-contingent tax on debt of about 1 percent on average supports the planner's allocations as a competitive equilibrium and increases social welfare.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2010)
Issue (Month): Oct ()
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Handle: RePEc:fip:fedfpr:y:2010:i:oct:x:4

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  1. Enrique G. Mendoza & Vincenzo Quadrini, 2009. "Financial Globalization, Financial Crises and Contagion," NBER Working Papers 15432, National Bureau of Economic Research, Inc.
  2. Miles S. Kimball & Matthew D. Shapiro, 2008. "Labor Supply: Are the Income and Substitution Effects Both Large or Both Small?," NBER Working Papers 14208, National Bureau of Economic Research, Inc.
  3. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  4. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  5. Mulligan, Casey B, 1997. "Scale Economies, the Value of Time, and the Demand for Money: Longitudinal Evidence from Firms," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1061-79, October.
  6. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  7. Javier Bianchi, 2009. "Overborrowing and systemic externalities in the business cycle," Working Paper 2009-24, Federal Reserve Bank of Atlanta.
  8. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  9. Stephanie Schmitt-Grohé & Martín Uribe, 2007. "Optimal simple and implementable monetary and fiscal rules," Working Paper 2007-24, Federal Reserve Bank of Atlanta.
  10. Nikolov, Kalin, 2010. "Is Private Leverage Excessive?," MPRA Paper 28407, University Library of Munich, Germany, revised Jun 2010.
  11. Aiyagari, S.R. & Gertler, M., 1998. ""Overreaction" of Asset Prices in General Equilibrium," Working Papers 98-25, C.V. Starr Center for Applied Economics, New York University.
  12. Chen, Kaiji & Song, Zheng, 2009. "Financial Frictions on Capital Allocation: A Transmission Mechanism of TFP Fluctuations," MPRA Paper 15211, University Library of Munich, Germany.
  13. Jeanne, Olivier & Korinek, Anton, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," CEPR Discussion Papers 8015, C.E.P.R. Discussion Papers.
  14. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  15. S. Rao Aiyagari & Mark Gertler, 1998. ""Overreaction" of Asset Prices in General Equilibrium," NBER Working Papers 6747, National Bureau of Economic Research, Inc.
  16. Guillermo A. Calvo & Alejandro Izquierdo & Rudy Loo-Kung, 2005. "Relative Price Volatility Under Sudden Stops: The Relevance of Balance Sheet Effects," NBER Working Papers 11492, National Bureau of Economic Research, Inc.
  17. Reinhart, Carmen & Rogoff, Kenneth, 2009. "Banking Crises: An Equal Opportunity Menace," CEPR Discussion Papers 7131, C.E.P.R. Discussion Papers.
  18. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  19. repec:fth:starer:9825 is not listed on IDEAS
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