Working Paper: NBER ID: w15484
Authors: Joshua Aizenman
Abstract: We outline the case for supporting self-insurance by imposing a tax on external borrowing in a model of an emerging market. Entrepreneurs finance tangible investments via bank intermediation of foreign borrowing, exposing the economy to negative fire-sale externalities at times of deleveraging; a risk that increases with the ratio of aggregate external borrowing to international reserves. Price taking economic agents ignore their marginal impact on the expected cost of a deleveraging crisis. The optimal borrowing tax reduces the distorted activity, external borrowing, and induces borrowers to co-finance the precautionary hoarding of international reserves.
Keywords: International Reserves; External Borrowing; Pigovian Tax; Emerging Markets; Financial Crises
JEL Codes: F15; F21; F32; F36; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| external borrowing (F34) | negative firesale externalities (D62) |
| negative firesale externalities (D62) | costly premature liquidation of investments (G33) |
| optimal tax on external borrowing (H21) | reduces excessive borrowing (G51) |
| optimal tax on external borrowing (H21) | encourages precautionary hoarding of international reserves (F31) |
| marginal social benefit of hoarding IR > private benefit of hoarding IR during crises (H84) | proposed tax-subsidy scheme corrects misalignment (H23) |
| proposed policies (D78) | alleviate concerns regarding costs of hoarding IR (G52) |
| proposed policies (D78) | support stability of emerging markets during financial crises (F65) |