Managing Credit Booms and Busts: A Pigouvian Taxation Approach

Jeanne, Olivier; Korinek, Anton

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Managing Credit Booms and Busts: A Pigouvian Taxation Approach

CEPR Discussion Paper No. DP8015

46 Pages Posted: 14 Nov 2010

See all articles by Olivier Jeanne

Olivier Jeanne

International Monetary Fund (IMF) - Research Department; Ecole Nationale des Ponts et Chaussees (ENPC); Centre for Economic Policy Research (CEPR)

Anton Korinek

University of Virginia; National Bureau of Economic Research (NBER)

There are 3 versions of this paper

Date Written: September 2010

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, macro-prudential regulation, precautionary savings, systemic externalities

JEL Classification: E44, G38

Suggested Citation: Suggested Citation

Jeanne, Olivier and Korinek, Anton, Managing Credit Booms and Busts: A Pigouvian Taxation Approach (September 2010). CEPR Discussion Paper No. DP8015, Available at SSRN: https://ssrn.com/abstract=1707905