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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

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Listed author(s):
  • Olivier Jeanne

    ()

    (Peterson Institute for International Economics)

  • Anton Korinek

Abstract

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 with reference to (1) the US small and medium-sized enterprise sector and (2) 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 Peterson Institute for International Economics in its series Working Paper Series with number WP10-12.

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Date of creation: Sep 2010
Handle: RePEc:iie:wpaper:wp10-12
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Keywords: boom-bust cycles; financial crises; systemic externalities; macroprudential regulation; precautionary savings;

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Find related papers by JEL classification:
  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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  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.
  2. Christopher D. Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," Economics Working Paper Archive 517, The Johns Hopkins University,Department of Economics.
  3. Enrique G. Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  4. Jonathan David Ostry & Atish R. Ghosh & Karl F Habermeier & Marcos d Chamon & Mahvash S Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
  5. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," American Economic Review, American Economic Association, vol. 100(2), pages 403-407, May.
  6. 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.
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  8. 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.
  9. 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.
  10. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  11. 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.
  12. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  13. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  14. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
  15. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
  16. Urban Jermann & Vincenzo Quadrini, 2012. "Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(1), pages 238-271, February.
  17. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradable Goods in Economies Prone to Sudden Stops," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, vol. 0(Fall 2005), pages 103-148, August.
  18. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, vol. 58(2), pages 867-894, 04.
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