Overborrowing, Financial Crises and ‘Macro-prudential’ Policy

Author/Editor:

Enrique G. Mendoza ; Javier Bianchi

Publication Date:

February 1, 2011

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper studies overborrowing, financial crises and macro-prudential policy in an equilibrium model of business cycles and asset prices with collateral constraints. Agents in a decentralized competitive equilibrium do not internalize the negative effects of asset fire-sales on the value of other agents' assets and hence they borrow too much" ex ante, compared with a constrained social planner who internalizes these effects. Average debt and leverage ratios are slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises are much larger. Excess asset returns, Sharpe ratios and the market price of risk are also much larger. State-contigent taxes on debt and dividends of about 1 and -0.5 percent on average respectively support the planner’s allocations as a competitive equilibrium and increase social welfare.

Series:

Working Paper No. 11/24

Subject:

English

Publication Date:

February 1, 2011

ISBN/ISSN:

9781455216710/1018-5941

Stock No:

WPIEA2011024

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

53

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