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Hoarding international reserves versus a Pigovian tax-cum-subsidy scheme: Reflections on the deleveraging crisis of 2008-2009, and a cost benefit analysis

  • Aizenman, Joshua

We outline the case for supporting self-insurance by imposing a tax on external borrowing in a model of an emerging market. Entrepreneurs finance tangible investments via bank intermediation of foreign borrowing, exposing the economy to negative fire-sale externalities at times of deleveraging; a risk that increases with the ratio of aggregate external borrowing to international reserves. Price taking economic agents ignore their marginal impact on the expected cost of a deleveraging crisis. The optimal borrowing tax reduces the distorted activity, external borrowing, and induces borrowers to co-finance the precautionary hoarding of international reserves.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 9 (September)
Pages: 1502-1513

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:9:p:1502-1513
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