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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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Bibliographic Info

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. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 16270, University Library of Munich, Germany.
  2. Reinhart, Carmen M. & Rogoff, Kenneth S., 2013. "Banking crises: An equal opportunity menace," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4557-4573.
  3. Nikolov, Kalin, 2010. "Is Private Leverage Excessive?," MPRA Paper 28407, University Library of Munich, Germany, revised Jun 2010.
  4. Olivier Jeanne & Anton Korinek, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," NBER Working Papers 16377, National Bureau of Economic Research, Inc.
  5. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  6. 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.
  7. 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.
  8. 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.
  9. S. Rao Aiyagari & Mark Gertler, 1998. ""Overreaction" of Asset Prices in General Equilibrium," NBER Working Papers 6747, National Bureau of Economic Research, Inc.
  10. Calvo, Guillermo A. & Izquierdo, Alejandro & Loo-Kung, Rudy, 2006. "Relative price volatility under Sudden Stops: The relevance of balance sheet effects," Journal of International Economics, Elsevier, vol. 69(1), pages 231-254, June.
  11. 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.
  12. 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.
  13. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  14. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers 4334, C.E.P.R. Discussion Papers.
  15. 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.
  16. Chen, Kaiji & Song, Zheng, 2009. "Financial Frictions on Capital Allocation: A Transmission Mechanism of TFP Fluctuations," MPRA Paper 15211, University Library of Munich, Germany.
  17. Vincenzo Quadrini & Enrique G. Mendoza, 2010. "Financial Globalization, Financial Crises and Contagion," 2010 Meeting Papers 841, Society for Economic Dynamics.
  18. 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.
  19. repec:fth:starer:9825 is not listed on IDEAS
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