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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

  • Jeanne, Olivier
  • Korinek, Anton

We study a dynamic model in which the interaction between debt accumulation and asset prices magnifies credit booms and busts. We find that borrowers do not internalize these feedback effects and therefore suffer from excessively large booms and busts in both credit flows and asset prices. We show that a Pigouvian tax on borrowing may induce borrowers to internalize these externalities and increase welfare. We calibrate the model by reference to (i) the US small and medium-sized enterprise sector and (ii) the household sector, and find the optimal tax to be countercyclical in both cases, dropping to zero in busts and rising to approximately half a percentage point of the amount of debt outstanding during booms.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8015.

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Date of creation: Sep 2010
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Handle: RePEc:cpr:ceprdp:8015
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  1. Enrique G. Mendoza & Katherine A. Smith, 2004. "Quantitative Implication of A Debt-Deflation Theory of Sudden Stops and Asset Prices," NBER Working Papers 10940, National Bureau of Economic Research, Inc.
  2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  3. repec:bla:restud:v:75:y:2008:i:3:p:809-833 is not listed on IDEAS
  4. Javier Bianchi, 2009. "Overborrowing and systemic externalities in the business cycle," Working Paper 2009-24, Federal Reserve Bank of Atlanta.
  5. Jermann, Urban & Quadrini, Vincenzo, 2009. "Macroeconomic Effects of Financial Shocks," CEPR Discussion Papers 7451, C.E.P.R. Discussion Papers.
  6. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
  7. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," NBER Working Papers 15927, National Bureau of Economic Research, Inc.
  8. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," NBER Working Papers 11691, National Bureau of Economic Research, Inc.
  9. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  10. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  11. Carroll, Christopher D., 2006. "The method of endogenous gridpoints for solving dynamic stochastic optimization problems," Economics Letters, Elsevier, vol. 91(3), pages 312-320, June.
  12. Christopher D. Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," Economics Working Paper Archive 517, The Johns Hopkins University,Department of Economics.
  13. Anton Korinek, 2011. "Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses," NFI Working Papers 2011-WP-13, Indiana State University, Scott College of Business, Networks Financial Institute.
  14. Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  15. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  16. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
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