Managing Credit Booms and Busts: A Pigouvian Taxation Approach

43 Pages Posted: 17 Sep 2010 Last revised: 23 Feb 2022

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)

Multiple version iconThere are 3 versions of this paper

Date Written: September 15, 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 with reference to (1) the US small and medium-sized enterprise sector and (2) the household sector and find the optimal tax to be counter-cyclical 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, systemic externalities, macroprudential regulation, precautionary savings

JEL Classification: E44, G38

Suggested Citation

Jeanne, Olivier and Korinek, Anton, Managing Credit Booms and Busts: A Pigouvian Taxation Approach (September 15, 2010). Peterson Institute for International Economics Working Paper No. 10-12, Available at SSRN: https://ssrn.com/abstract=1677581 or http://dx.doi.org/10.2139/ssrn.1677581

Olivier Jeanne (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

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Centre for Economic Policy Research (CEPR)

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Anton Korinek

University of Virginia

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National Bureau of Economic Research (NBER) ( email )

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