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Overborrowing, Financial Crises and 'Macro-prudential' Policy

  • Javier Bianchi

    (University of Maryland)

  • Enrique G. Mendoza

    (University of Maryland & NBER)

This paper studies overborrowing, financial crises and macro-prudential policy in an equilibrium model of business cycles and asset prices with collateral constraints. Agents in a decentralized competitive equilibrium do not internalize the negative effects of asset fire-sales on the value of other agents' assets and hence they borrow "too much" ex ante, compared with a constrained social planner who internalizes these effects. Average debt and leverage ratios are slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises are much larger. Excess asset returns, Sharpe ratios and the market price of risk are also much larger. State-contingent taxes on debt and dividends of about 1 and -0.5 percent on average respectively support the planner's allocations as a competitive equilibrium and increase social welfare.

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File URL: https://economicdynamics.org/meetpapers/2011/paper_175.pdf
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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 175.

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Date of creation: 2011
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Handle: RePEc:red:sed011:175
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
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