Managing Credit Booms and Busts: A Pigouvian Taxation Approach
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.
The authors would like to thank David Cook, C. Bora Durdu, Enrique Mendoza, Raoul Minetti, Joseph Stiglitz and Dimitri Vayanos as well as participants at seminars at the FRB and at JHU and at the Dallas Fed/Bank of Canada conference on Capital Flows, an IMF Workshop on Systemic Risk, the 2nd Tilburg Financial Stability Conference and the Paul Woolley Conference on Capital Market Dysfunctionality for helpful comments and suggestions. Financial support from the Europlace Institute of Finance is gratefully acknowledged. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Olivier Jeanne & Anton Korinek, 2018. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," Journal of Monetary Economics, . citation courtesy of