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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

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  • Olivier Jeanne
  • 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 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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16377.

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Date of creation: Sep 2010
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Handle: RePEc:nbr:nberwo:16377

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  1. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," NBER Working Papers 11691, National Bureau of Economic Research, Inc.
  2. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
  3. Urban Jermann & Vincenzo Quadrini, 2009. "Macroeconomic Effects of Financial Shocks," NBER Working Papers 15338, National Bureau of Economic Research, Inc.
  4. Christopher D. Carroll, 2005. "The Method of Endogenous Gridpoints for Solving Dynamic Stochastic Optimization Problems," NBER Technical Working Papers 0309, National Bureau of Economic Research, Inc.
  5. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  6. Christopher Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," NBER Working Papers 10867, National Bureau of Economic Research, Inc.
  7. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  8. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
  9. Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  10. Korinek, Anton, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
  11. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  12. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," NBER Working Papers 15927, National Bureau of Economic Research, Inc.
  13. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  14. 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.
  15. 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.
  16. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
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