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Overborrowing, financial crises and ‘macro-prudential’ taxes

Author

Listed:
  • Enrique G. Mendoza
  • Javier Bianchi

Abstract

We study overborrowing and financial crises in an equilibrium model of business cycles and asset prices with collateral constraints. Private agents in a decentralized competitive equilibrium do not internalize the effects of their individual borrowing plans on the market price of assets at which collateral is valued and on the wage costs relevant for working capital financing. Compared with a constrained social planner who internalizes these effects, they undervalue the benefits of an increase in net worth when the constraint binds and hence they borrow "too much" ex ante. Quantitatively, average debt and leverage ratios are only slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises is much larger. Excess asset returns, Sharpe ratios and the market price of risk are also much larger. A state-contingent tax on debt of about 1 percent on average supports the planner's allocations as a competitive equilibrium and increases social welfare.

Suggested Citation

  • Enrique G. Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  • Handle: RePEc:fip:fedfpr:y:2010:i:oct:x:4
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    References listed on IDEAS

    as
    1. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
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    More about this item

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • 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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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