Overborrowing and Systemic Externalities in the Business Cycle Under Imperfect Information

47 Pages Posted: 5 Jun 2020 Last revised: 22 Aug 2023

See all articles by Juan David Herreño

Juan David Herreño

University of California, San Diego (UCSD)

Carlos Rondón-Moreno

Central Bank of Chile

Date Written: August 15, 2023

Abstract

We study the interaction between imperfect information and financial frictions and its role in driving financial crises in small open economies. We use a model where households observe income growth but do not perceive whether the underlying shocks are permanent or transitory, and borrowing is subject to a collateral constraint. The optimal macroprudential policy helps stabilize the economy by actively taxing debt. We show that the combination of imperfect information and a borrowing constraint is a significant source of economic instability. The optimal tax under these conditions is six times larger than the tax in the perfect information limit.

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 (August 15, 2023). Available at SSRN: https://ssrn.com/abstract=3597734 or http://dx.doi.org/10.2139/ssrn.3597734

Juan David Herreño

University of California, San Diego (UCSD) ( email )

9500 Gilman Drive
La Jolla, CA 92093
United States

Carlos Rondón-Moreno (Contact Author)

Central Bank of Chile ( email )

Publicaciones
Huerfanos 1185
Santiago
Chile

HOME PAGE: http://www.carlosrondonmoreno.com/

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