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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

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  • Jeanne, Olivier
  • Korinek, Anton

Abstract

We study a dynamic model in which the interaction between debt accumulation and asset prices magnifies credit booms and busts. We find that borrowers do not internalize these feedback effects and therefore suffer from excessively large booms and busts in both credit flows and asset prices. We show that a Pigouvian tax on borrowing may induce borrowers to internalize these externalities and increase welfare. We calibrate the model by reference to (i) the US small and medium-sized enterprise sector and (ii) the household sector, and find the optimal tax to be countercyclical in both cases, dropping to zero in busts and rising to approximately half a percentage point of the amount of debt outstanding during booms.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8015.

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Date of creation: Sep 2010
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Handle: RePEc:cpr:ceprdp:8015

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Keywords: boom-bust cycles; financial crises; macro-prudential regulation; precautionary savings; systemic externalities;

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References

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  1. Enrique G. Mendoza & Katherine A. Smith, 2004. "Quantitative Implication of A Debt-Deflation Theory of Sudden Stops and Asset Prices," NBER Working Papers 10940, National Bureau of Economic Research, Inc.
  2. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  3. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  4. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," American Economic Review, American Economic Association, vol. 100(2), pages 403-07, May.
  5. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
  6. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  7. Christopher Carroll, 2005. "The Method of Endogenous Gridpoints for Solving Dynamic Stochastic Optimization Problems," Economics Working Paper Archive 520, The Johns Hopkins University,Department of Economics.
  8. Urban Jermann & Vincenzo Quadrini, 2012. "Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(1), pages 238-71, February.
  9. Christopher Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," NBER Working Papers 10867, National Bureau of Economic Research, Inc.
  10. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 15114, University Library of Munich, Germany.
  11. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  12. Jonathan David Ostry & Mahvash Saeed Qureshi & Karl Friedrich Habermeier & Dennis B. S. Reinhardt & Marcos Chamon & Atish R. Ghosh, 2010. "Capital Inflows: The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
  13. Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  14. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
  15. Enrique G. Mendoza, 2006. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," IMF Working Papers 06/88, International Monetary Fund.
  16. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
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