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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

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  • Olivier Jeanne

    ()
    (Peterson Institute for International Economics)

  • Anton Korinek

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 with reference to (1) the US small and medium-sized enterprise sector and (2) 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 Peterson Institute for International Economics in its series Working Paper Series with number WP10-12.

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Date of creation: Sep 2010
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Handle: RePEc:iie:wpaper:wp10-12

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

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  1. Jermann, Urban & Quadrini, Vincenzo, 2009. "Macroeconomic Effects of Financial Shocks," CEPR Discussion Papers 7451, C.E.P.R. Discussion Papers.
  2. Christopher D. Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," Economics Working Paper Archive 517, The Johns Hopkins University,Department of Economics.
  3. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," NBER Working Papers 15927, National Bureau of Economic Research, Inc.
  4. 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.
  5. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
  6. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  7. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 16270, University Library of Munich, Germany.
  8. 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.
  9. Carroll, Christopher D., 2005. "The method of endogenous gridpoints for solving dynamic stochastic optimization problems," CFS Working Paper Series 2005/18, Center for Financial Studies (CFS).
  10. Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  11. 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.
  12. 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.
  13. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
  14. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  15. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
  16. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows," IMF Staff Position Notes 2010/04, International Monetary Fund.
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