Corrective Regulation with Imperfect Instruments

87 Pages Posted: 2 Sep 2021 Last revised: 12 May 2022

See all articles by Eduardo Davila

Eduardo Davila

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Ansgar Walther

Imperial College London; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 5 versions of this paper

Date Written: August 10, 2021

Abstract

This paper studies optimal second-best corrective regulation, when some agents/activities cannot be perfectly regulated. We show that policy elasticities and Pigouvian wedges are sufficient statistics to characterize the marginal welfare impact of regulatory policies in a large class of environments. We show that a subset of policy elasticities, leakage elasticities, determine optimal second-best policy, and characterize the marginal value of relaxing regulatory constraints. We apply our results to scenarios with unregulated agents/activities, uniform regulation across agents/activities, and costly regulation. We illustrate our results in applications to financial regulation with environmental externalities, shadow banking, behavioral distortions, asset substitution, and fire sales.

Keywords: corrective regulation, second-best policy, Pigouvian taxation, policy elasticities, leakage elasticities, regulatory arbitrage, financial regulation, environmental externalities

JEL Classification: G18, G28, H21, D62

Suggested Citation

Davila, Eduardo and Walther, Ansgar, Corrective Regulation with Imperfect Instruments (August 10, 2021). Available at SSRN: https://ssrn.com/abstract=3902824 or http://dx.doi.org/10.2139/ssrn.3902824

Eduardo Davila

Yale University - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ansgar Walther (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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