Overborrowing and Systemic Externalities in the Business Cycle Under Imperfect Information

Juan Herreño and Carlos Rondón-Moreno

Working Papers Central Bank of Chile from Central Bank of Chile

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 taxing debt procyclically. We show that the combination of imperfect information and borrowing constraints 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.

Date: 2022-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fdg and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:chb:bcchwp:940

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