DISCUSSION: Overborrowing, Financial Crisis and Macroprudential Taxes By Javier Bianchi, Enrique G. Mendoza; 2010

Overview 1.Summary 2.Contribution to the literature 3.Extension – Inclusion of banks 3.1 Transmission of shocks to the real economy 3.2 Collateral constraint as sole credit friction 3.3 Different kind of prudential policies

1. Summary Questions: 1.Does overborrowing cause financial crisis and drive business cycle fluctuations? 2.Can policy-makers adopt macroprudential tools to reduce financial fragility? Motivation: 2008 global financial crisis and adoption of macroprudential polies in its aftermath

1. Summary -DSGE model with occasionally binding credit constraint calibrated to annual US data -Compare equilibrium outcomes of private borrowing with credit frictions where agents take asset prices as given versus a social planner's outcome where the effects of individual actions on asset prices are internalized -Thus introducing a macroprudential tax to discourage lending in unconstraint times taking the amplification of negative asset price movements with a binding borrowing constraint into account Results: Financial crisis in the competitive equilibrium are significantly more frequent and deep than in the equilibrium attained by the regulator.

2. Contribution of the literature Asset prices as key factor driving debt dynamics and credit externalities Quantifies the difference in regulated versus competitive outcomes in an equilibrium model of business cycles and asset prices

Overview 1.Summary 2.Contribution to the literature 3.Extension – Inclusion of banks 3.1 Transmission of shocks to the real economy 3.2 Collateral constraint as sole credit friction 3.3 Different kind of prudential policies

3.1 Transmission to the real economy Due to aggregation of all private agents into household-firms, neglects the special role of financial intermediaries Incomplete picture of the transmission of fin. shocks to the real economy Shuts-down important transmission channels of crisis i.e. bank lending and bank balance sheets channel

3.2 Collateral constraint as sole credit friction The nature of the recent crisis being born out of the mortgage segment made collateral constraints due to market movements of asset prices important There are financial crisis like the Asian crisis that are closely linked to overborrowing which were much less linked to asset price movements in the first place Introduction of banks allows for the introduction of more frictions (i.e. Dib 2010 style)

3.4 Different kinds of macroprudential policies Strain of the literature (i.e. Greenspan 2002, 2011; Blinder and Reis 2005) argues that restricting in-debtness ex-ante is too costly compared to “mopping-up” after the crisis A model with banks would allow for the implementation of different kind of macroprudential policies like counter-cyclical capital requirements