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Is Private Leverage Excessive?

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  • Nikolov, Kalin

Abstract

I examine whether a benevolent government can improve on the free market allocation by setting capital requirements for private borrowers in a stochastic model with collateral constraints. Previous theoretical studies have found that when asset prices enter into bor- rowing constraints, pecuniary externalities between atomistic agents can make the laissez faire equilibrium constrained ine¢ cient. For reasonable parameter values, I find that, quan- titatively, the answer is 'no', private and government leverage choices coincide. Limiting private leverage by imposing capital requirements has the beneficial e¤ect of dampening the effects of the collateral amplification mechanism. This reduces fire sales in recessions and limits the negative externality that individual asset sales have on other credit constrained borrowers. However, we find that capital requirements are a blunt tool. They tax the activities of highly productive entrepreneurs and reduce the amount they produce in equilibrium. This reduces total factor productivity and steady state consumption. In the end, society faces a choice between high but unstable consumption in the free borrowing world and low but stable consumption in the regulated world. The government chooses the former.

Suggested Citation

  • Nikolov, Kalin, 2010. "Is Private Leverage Excessive?," MPRA Paper 28407, University Library of Munich, Germany, revised Jun 2010.
  • Handle: RePEc:pra:mprapa:28407
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    File URL: https://mpra.ub.uni-muenchen.de/28407/1/MPRA_paper_28407.pdf
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    References listed on IDEAS

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    Cited by:

    1. Hirano, Tomohiro & Inaba, Masaru & Yanagawa, Noriyuki, 2015. "Asset bubbles and bailouts," Journal of Monetary Economics, Elsevier, vol. 76(S), pages 71-89.
    2. Enrique G. Mendoza & Javier Bianchi, 2011. "Overborrowing, Financial Crises and ‘Macro-prudential’ Policy," IMF Working Papers 11/24, International Monetary Fund.
    3. Oliver de Groot, 2014. "The Risk Channel of Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 115-160, June.
    4. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2011. "Revisiting Overborrowing and its Policy Implications," Central Banking, Analysis, and Economic Policies Book Series,in: Luis Felipe Céspedes & Roberto Chang & Diego Saravia (ed.), Monetary Policy under Financial Turbulence, edition 1, volume 16, chapter 6, pages 145-184 Central Bank of Chile.
    5. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R., 2013. "Financial crises and macro-prudential policies," Journal of International Economics, Elsevier, vol. 89(2), pages 453-470.
    6. Enrique G. Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
    7. Caterina Mendicino, 2012. "Collateral Requirements: Macroeconomic Fluctuations and Macro-Prudential Policy," Working Papers w201211, Banco de Portugal, Economics and Research Department.
    8. Anton Korinek, 2011. "The New Economics of Capital Controls Imposed for Prudential Reasons+L4888," IMF Working Papers 11/298, International Monetary Fund.
    9. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 17-34.

    More about this item

    Keywords

    Collateral constraints; Capital Requirements;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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