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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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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. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," NBER Working Papers 15927, National Bureau of Economic Research, Inc.
  2. Carroll, Christopher D., 2005. "The method of endogenous gridpoints for solving dynamic stochastic optimization problems," CFS Working Paper Series, Center for Financial Studies (CFS) 2005/18, Center for Financial Studies (CFS).
  3. Urban Jermann & Vincenzo Quadrini, 2012. "Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, American Economic Association, vol. 102(1), pages 238-71, February.
  4. 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, Elsevier, vol. 70(1), pages 82-114, September.
  5. 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, American Economic Association, vol. 87(5), pages 893-910, December.
  6. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 101(7), pages 3400-3426, December.
  7. Christopher D. Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," Economics Working Paper Archive, The Johns Hopkins University,Department of Economics 517, The Johns Hopkins University,Department of Economics.
  8. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 19(3), pages 418-437, July.
  9. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 155, Oesterreichische Nationalbank (Austrian Central Bank).
  10. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  11. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
  12. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-03, C.V. Starr Center for Applied Economics, New York University.
  13. Javier Bianchi & Enrique G. Mendoza, 2010. "Overborrowing, Financial Crises and 'Macro-prudential' Taxes," NBER Working Papers 16091, National Bureau of Economic Research, Inc.
  14. 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, International Monetary Fund 2010/04, International Monetary Fund.
  15. 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.
  16. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series, European Central Bank 1345, European Central Bank.
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