Overborrowing, Financial Crises and 'Macro-prudential' Taxes

Javier Bianchi and Enrique Mendoza

No 16091, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: An equilibrium model of financial crises driven by Irving Fisher's financial amplification mechanism features a pecuniary externality, because private agents do not internalize how the price of assets used for collateral respond to collective borrowing decisions, particularly when binding collateral constraints cause asset fire-sales and lead to a financial crisis. As a result, agents in the competitive equilibrium borrow "too much" ex ante, compared with a financial regulator who internalizes the externality. Quantitative analysis calibrated to U.S. data shows that average debt and leverage are only slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises are much larger. Excess asset returns, Sharpe ratios and the price of risk are also much larger, and the distribution of returns displays endogenous fat tails. State-contingent taxes on debt and dividends of about 1 and -0.5 percent on average respectively support the regulator's allocations as a competitive equilibrium.

JEL-codes: D62 E32 E44 F32 F41 (search for similar items in EconPapers)
Date: 2010-06
New Economics Papers: this item is included in nep-ban
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Published as Enrique Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and âmacro-prudentialâ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.

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