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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
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Aizenman, Joshua & Lee, Yeonho & Rhee, Youngseop, 2007. "International reserves management and capital mobility in a volatile world: Policy considerations and a case study of Korea," Journal of the Japanese and International Economies, Elsevier, vol. 21(1), pages 1-15, March.
  2. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
  3. Levy-Yeyati, Eduardo & Sturzenegger, Federico & Gluzmann, Pablo, 2007. "Fear of Appreciation," MPRA Paper 42917, University Library of Munich, Germany, revised Nov 2012.
  4. Joshua Aizenman & Jaewoo Lee, 2005. "International reserves: precautionary versus mercantilist views, theory and evidence," Proceedings, Federal Reserve Bank of San Francisco.
  5. Ricardo Caballero & Arvind Krishnamurthy, 2001. "Smoothing Sudden Stops," NBER Working Papers 8427, National Bureau of Economic Research, Inc.
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  7. Joshua Aizenman & Yi Sun, 2009. "The Financial Crisis and Sizable International Reserves Depletion: From 'Fear of Floating' to the 'Fear of Losing International Reserves'?," Working Papers 382009, Hong Kong Institute for Monetary Research.
  8. Rodrik, Dani, 2006. "The Social Cost of Foreign Exchange Reserves," CEPR Discussion Papers 5483, C.E.P.R. Discussion Papers.
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  12. Eduardo Levy Yeyati, 2008. "Liquidity Insurance in a Financially Dollarized Economy," NBER Chapters, in: Financial Markets Volatility and Performance in Emerging Markets, pages 185-218 National Bureau of Economic Research, Inc.
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  14. Dooley, Michael P., 2000. "International financial architecture and strategic default: can financial crises be less painful?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 361-377, December.
  15. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 16270, University Library of Munich, Germany.
  16. Anthony Pennington-Cross, 2006. "The Value of Foreclosed Property," Journal of Real Estate Research, American Real Estate Society, vol. 28(2), pages 193-214.
  17. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, vol. 94(374), pages 287-307, June.
  18. Paul Krugman, 2000. "Fire-Sale FDI," NBER Chapters, in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 43-58 National Bureau of Economic Research, Inc.
  19. Terrence M. Clauretie & Nasser Daneshvary, 2009. "Estimating the House Foreclosure Discount Corrected for Spatial Price Interdependence and Endogeneity of Marketing Time," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 37(1), pages 43-67.
  20. Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2003. "Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why it Matters," NBER Working Papers 10036, National Bureau of Economic Research, Inc.
  21. Gianluca Benigno & Huigang Chen & Chris Otrok & Alessandro Rebucci & Eric Young, 2010. "Revisiting Overborrowing and Its Policy Implications," CEP Discussion Papers dp1020, Centre for Economic Performance, LSE.
  22. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
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