Corrective Regulation with Imperfect Instruments
87 Pages Posted: 2 Sep 2021 Last revised: 12 May 2022
There are 5 versions of this paper
Corrective Regulation with Imperfect Instruments
Corrective Regulation with Imperfect Instruments
Corrective Regulation with Imperfect Instruments
Corrective Regulation with Imperfect Instruments
Corrective Regulation with Imperfect Instruments
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: Suggested Citation