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Overborrowing, Financial Crises and 'Macro-prudential' Taxes

  • Javier Bianchi
  • Enrique G. Mendoza

An equilibrium model of financial crises driven by Irving Fisher's financial amplification mechanism features a pecuniary externality, because private agents do not internalize how the price of assets used for collateral respond to collective borrowing decisions, particularly when binding collateral constraints cause asset fire-sales and lead to a financial crisis. As a result, agents in the competitive equilibrium borrow "too much" ex ante, compared with a financial regulator who internalizes the externality. Quantitative analysis calibrated to U.S. data shows that average debt and leverage are only slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises are much larger. Excess asset returns, Sharpe ratios and the price of risk are also much larger, and the distribution of returns displays endogenous fat tails. State-contingent taxes on debt and dividends of about 1 and -0.5 percent on average respectively support the regulator's allocations as a competitive equilibrium.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16091.

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Date of creation: Jun 2010
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Publication status: published as Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
Handle: RePEc:nbr:nberwo:16091
Note: EFG IFM
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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. Javier Bianchi, 2010. "Overborrowing and Systemic Externalities in the Business Cycle," 2010 Meeting Papers 96, Society for Economic Dynamics.
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