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Overborrowing and systemic externalities in the business cycle under imperfect information

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  • Herreño, Juan
  • Rondón-Moreno, Carlos

Abstract

We study the interaction between imperfect information and financial frictions and their role in financial crises in small open economies. We use a model where households observe income growth but cannot distinguish whether the underlying income shocks are permanent or transitory, and borrowing is subject to a collateral constraint. We show that the combination of imperfect information and a borrowing constraint is a significant source of economic instability. Optimal macroprudential policy helps stabilize the economy by actively taxing debt. Furthermore, the interaction between the collateral constraint and the information friction reshapes the correlation between the optimal tax and the underlying components of income.

Suggested Citation

  • Herreño, Juan & Rondón-Moreno, Carlos, 2025. "Overborrowing and systemic externalities in the business cycle under imperfect information," Journal of International Economics, Elsevier, vol. 157(C).
    • Handle: RePEc:eee:inecon:v:157:y:2025:i:c:s0022199625000595
    DOI: 10.1016/j.jinteco.2025.104103
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    Keywords

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    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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