Overborrowing, Financial Crises and 'Macro-Prudential' Taxes

62 Pages Posted: 21 Jun 2010

See all articles by Javier Bianchi

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Enrique G. Mendoza

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

Date Written: June 2010

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.

Suggested Citation

Bianchi, Javier and Mendoza, Enrique G., Overborrowing, Financial Crises and 'Macro-Prudential' Taxes (June 2010). NBER Working Paper No. w16091, Available at SSRN: https://ssrn.com/abstract=1626581

Javier Bianchi (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

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