WORKING PAPER 10-12

Managing Credit Booms and Busts: A Pigouvian Taxation Approach

by Olivier Jeanne, Peterson Institute for International Economics
and Anton Korinek, University of Maryland

September 2010

The interaction between debt accumulation and asset prices contributes to magnify the impact of booms and busts in an economy. Increases in borrowing and in collateral prices feed each other during booms. In busts, the feedback turns negative, with credit constraints leading to firesales of assets and further tightening of credit. Prudential policies could be used to mitigate the build-up in systemic vulnerability during a boom. However, there are few formal welfare analyses of optimal policies to deal with booms and busts in credit and asset prices. In this paper, the authors attempt to fill the gap with a dynamic optimizing model of collateralized borrowing. The economy suffers from excessive volatility, i.e., large booms and busts in both credit flows and asset prices. Jeanne and Korinek show that a Pigouvian tax on borrowing may induce individual borrowers to internalize these externalities and increase welfare. They calibrate the model with reference to the US small and medium enterprise and household sectors and find the optimal tax to be countercyclical, dropping to zero in busts and rising to approximately half a percentage point of the amount of debt outstanding in booms.

View full document [pdf]


RELATED LINKS

Book: From Stress to Growth: Strengthening Asia's Financial Systems in a Post-Crisis World October 2015

Op-ed: Failure at the Financial Stability Board November 30, 2015

Working Paper 15-16: Further Statistical Debate on "Too Much Finance" October 2015

Policy Brief 15-15: Fiscal Tightening and Economic Growth: Exploring Cross-Country Correlations September 2015

Testimony: The Role of Bankruptcy Reform in Addressing Too Big To Fail July 29, 2015

Policy Brief 14-23: Why Bail-In Securities Are Fool’s Gold November 2014

Op-ed: A Dose of Reality for the Dismal Science April 19, 2013

Op-ed: Five Myths about the Euro Crisis September 7, 2012

Policy Brief 12-18: The Coming Resolution of the European Crisis: An Update June 2012

Book: Resolving the European Debt Crisis March 2012

Book: Sovereign Wealth Funds: Threat or Salvation? September 2010

Policy Brief 11-15: Sustainability of Greek Public Debt October 2011

Testimony: The Euro Area Crisis: Origin, Current Status, and European and US Responses October 27, 2011



© 2016 Peter G. Peterson Institute for International Economics. 1750 Massachusetts Avenue, NW.
Washington, DC 20036. Tel: 202-328-9000 Fax: 202-659-3225 / 202-328-5432
Site development and hosting by Digital Division