Working Paper: CEPR ID: DP8015
Authors: Olivier Jeanne; 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 by reference to (i) the US small and medium-sized enterprise sector and (ii) 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.
Keywords: boom-bust cycles; financial crises; macroprudential regulation; precautionary savings; systemic externalities
JEL Codes: E44; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| debt accumulation (H63) | systemic externalities (D62) |
| systemic externalities (D62) | undervaluation of liquidity benefits (G33) |
| Pigouvian tax on borrowing (H23) | internalization of externalities (D62) |
| internalization of externalities (D62) | reduction in socially excessive debt levels (F65) |
| debt levels during booms (F65) | significant negative consequences during busts (E32) |