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Corrective regulation with imperfect instruments

Author

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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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    References listed on IDEAS

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    More about this item

    Keywords

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

    JEL classification:

    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D62 - Microeconomics - - Welfare Economics - - - Externalities

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