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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

  • Olivier Jeanne

    ()

    (Peterson Institute for International Economics)

  • Anton Korinek

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
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Handle: RePEc:iie:wpaper:wp10-12
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  1. Bianchi, Javier, 2009. "Overborrowing and Systemic Externalities in the Business Cycle," MPRA Paper 15114, University Library of Munich, Germany.
  2. Christopher D. Carroll, 2005. "The Method of Endogenous Gridpoints for Solving Dynamic Stochastic Optimization Problems," NBER Technical Working Papers 0309, National Bureau of Economic Research, Inc.
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  5. 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.
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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. 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.
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  13. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  14. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," NBER Working Papers 15927, National Bureau of Economic Research, Inc.
  15. Enrique G. Mendoza, 2006. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," IMF Working Papers 06/88, International Monetary Fund.
  16. Anton Korinek, 2009. "Systemic Risk: Amplification Effects, Externalities, and Policy Responses," Working Papers 155, Oesterreichische Nationalbank (Austrian Central Bank).
  17. 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.
  18. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
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