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Is Private Leverage Excessive?

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  • Nikolov, Kalin

Abstract

I examine whether a benevolent government can improve on the free market allocation by setting capital requirements for private borrowers in a stochastic model with collateral constraints. Previous theoretical studies have found that when asset prices enter into bor- rowing constraints, pecuniary externalities between atomistic agents can make the laissez faire equilibrium constrained ine¢ cient. For reasonable parameter values, I find that, quan- titatively, the answer is 'no', private and government leverage choices coincide. Limiting private leverage by imposing capital requirements has the beneficial e¤ect of dampening the effects of the collateral amplification mechanism. This reduces fire sales in recessions and limits the negative externality that individual asset sales have on other credit constrained borrowers. However, we find that capital requirements are a blunt tool. They tax the activities of highly productive entrepreneurs and reduce the amount they produce in equilibrium. This reduces total factor productivity and steady state consumption. In the end, society faces a choice between high but unstable consumption in the free borrowing world and low but stable consumption in the regulated world. The government chooses the former.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 28407.

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Date of creation: Jun 2010
Date of revision: Jun 2010
Handle: RePEc:pra:mprapa:28407

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Keywords: Collateral constraints; Capital Requirements;

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References

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  1. Edward C Prescott & Robert M Townsend, 2010. "Pareto Optima and Competitive Equilibria With Adverse Selection and Moral Hazard," Levine's Working Paper Archive 2069, David K. Levine.
  2. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 15114, University Library of Munich, Germany.
  3. Francisco Covas & Wouter Denhaan, 2006. "The role of debt and equity finance over the business cycle," 2006 Meeting Papers 407, Society for Economic Dynamics.
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  8. Kosuke Aoki & Gianluca Benigno & Nobuhiro Kiyotaki, 2009. "Capital Flows and Asset Prices," CEP Discussion Papers dp0921, Centre for Economic Performance, LSE.
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Cited by:
  1. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2010. "Revisiting Overborrowing and Its Policy Implications," IDB Publications 6855, Inter-American Development Bank.
  2. Caterina Mendicino, 2012. "Collateral Requirements: Macroeconomic Fluctuations and Macro-Prudential Policy," Working Papers w201211, Banco de Portugal, Economics and Research Department.
  3. Tomohiro Hirano & Masaru Inaba & Noriyuki Yanagawa, 2012. "Asset Bubbles and Bailouts," CARF F-Series CARF-F-268, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  4. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages S17-S34.
  5. Anton Korinek, 2011. "The New Economics of Capital Controls Imposed for Prudential Reasons+L4888," IMF Working Papers 11/298, International Monetary Fund.
  6. Javier Bianchi & Enrique G. Mendoza, 2010. "Overborrowing, Financial Crises and 'Macro-prudential' Taxes," NBER Working Papers 16091, National Bureau of Economic Research, Inc.
  7. Enrique G. Mendoza & Javier Bianchi, 2011. "Overborrowing, Financial Crises and ‘Macro-Prudential’ Policy?," IMF Working Papers 11/24, International Monetary Fund.
  8. Javier Bianchi & Enrique G. Mendoza, 2011. "Overborrowing, Financial Crises and 'Macro-prudential' Policy," 2011 Meeting Papers 175, Society for Economic Dynamics.

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