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Corrective regulation with imperfect instruments

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  • Dávila, Eduardo
  • Walther, Ansgar

Abstract

This paper studies optimal second-best corrective regulation, when some agents/activities cannot be perfectly regulated. We show that policy elasticities and Pigouvian wedges are sufficient statistics to characterize the marginal welfare impact of regulatory policies in a large class of environments. We show that a subset of policy elasticities, leakage elasticities, determine optimal second-best policy, and characterize the marginal value of relaxing regulatory constraints. We apply our results to scenarios with unregulated agents/activities, uniform regulation across agents/activities, and costly regulation. We illustrate our results in applications to financial regulation with environmental externalities, shadow banking, behavioral distortions, asset substitution, and fire sales. JEL Classification: H23, Q58, G28, D62

Suggested Citation

  • Dávila, Eduardo & Walther, Ansgar, 2022. "Corrective regulation with imperfect instruments," Working Paper Series 2723, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20222723
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    Cited by:

    1. Eduardo Dávila, 2023. "Optimal Financial Transaction Taxes," Journal of Finance, American Finance Association, vol. 78(1), pages 5-61, February.
    2. Clayton, Christopher & Schaab, Andreas, 2023. "Regulation with Externalities and Misallocation in General Equilibrium," TSE Working Papers 23-1445, Toulouse School of Economics (TSE).
    3. Döttling, Robin & Rola-Janicka, Magdalena, 2023. "Too levered for Pigou: carbon pricing, financial constraints, and leverage regulation," Working Paper Series 2812, European Central Bank.
    4. Döttling, Robin & Rola-Janicka, Magdalena, 2023. "Too Levered for Pigou: Carbon Pricing, Financial Constraints, and Leverage Regulation," OSF Preprints ds7bx_v1, Center for Open Science.
    5. Giovanardi, Francesco & Kaldorf, Matthias, 2024. "Climate change and the macroeconomics of bank capital regulation," Discussion Papers 13/2024, Deutsche Bundesbank.

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    More about this item

    Keywords

    corrective regulation; Pigouvian taxation; second-best policy;
    All these keywords.

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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