Overborrowing and Systemic Externalities in the Business Cycle Under Imperfect Information

47 Pages Posted: 5 Jun 2020

See all articles by Juan Herreño

Juan Herreño

Columbia University, Graduate School of Arts and Sciences, Department of Economics

Carlos Rondón-Moreno

Central Bank of Chile

Date Written: May 10, 2020

Abstract

We relax the perfect information assumption in a small open economy with collateral constraints. Under such a condition, households observe income growth but do not perceive whether the underlying shocks are permanent or transitory. Further, the likelihood and severity of financial crises are increased by the interaction between the information friction and a pecuniary externality that emerges when households use an asset valued at market prices as collateral. Due to a more significant welfare loss, the optimal tax to restore constrained efficiency is six times larger than under perfect information.

Keywords: Overborrowing, macroprudential policy, information frictions, financial frictions

JEL Classification: D62, D84, E44, F32, F38, F41

Suggested Citation

Herreño, Juan David and Rondón-Moreno, Carlos, Overborrowing and Systemic Externalities in the Business Cycle Under Imperfect Information (May 10, 2020). Available at SSRN: https://ssrn.com/abstract=3597734 or http://dx.doi.org/10.2139/ssrn.3597734

Juan David Herreño

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

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Carlos Rondón-Moreno (Contact Author)

Central Bank of Chile ( email )

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