ECB-CFS Conference, 2010

1. ECB-CFS Conference, 2010 Discussion of Two Articles, by Olivier Jeanne & Anton Korinek; and Julien Bengui , on Measures to Alleviate Systemic Risk-taking

2. Jeanne and Korinek Article • Infinitely Lived Insiders w Power Utility • Incomes from Endowment and Capital • Borrowing from (Lending to) Outsiders • Consumption in a period t Constrained by Income + Capital Gains + Borrowing • Feasible Borrowing Constrained by the Current Value of the Capital Stock Held

3. Equilibrium and Externalities • Income Process Stochastic, assumed • Independently and identically distributed • Meant to capture Rare Large Shocks • In competitive equilibrium, prices adjust so that Insiders Hold All Capital Assets • Possibility of Multiple Equilibrium When feasible Borrowing/(Asset Value) “High”

4. Pigouvian Taxes on Debt • Social Planner is NOT a Dynamic Price- Taker. Respects Borrowing Constraint • Optimal Welfare Improving Policy is to levy State-contingent Borrowing Taxes • Alleviates Incomplete/Constrained Debt Market Pecuniary Externalities (Stiglitz) • Tax Zero if Planned Debt is Constrained

5. Calibration Results on Taxes • Shock: Income drop of 3.1-3.35 Percent • Debt is Initially of One-period Maturity • Relative Risk Aversion Coefficient of 2 • Feasible Borrowing/Collateral Ratio is Only 3.1% for Households, 4.6% SME • Based on Marginal Impacts 2008-2009

6. Main Numerical Results • Multiplicity an Issue when the Borrowing Ratio Constraint is above Nine Percent • Optimal (highest) Pigouvian Tax around 0.56 Percent, when Real Interest Rate/ Discount Rate slightly above 4 Percent • Serves to Increase Insiders’ Savings in “boom” states: high asset price & wealth

7. Shocks: Comparative Statics • Optimal Tax Increasing in the Maximum Borrowing to Collateral Ratio. However • At low Interest Rate Levels, the Optimal Tax May Fall to Zero, as the Allocations May become Constrained by Borrowing even in the High Endowment State, i.e., • Social Planner “Lets Insiders Indulge”

8. Further Comparative Statics • Optimal Prudential Tax Rate Decreases when Size of Shock Increases. Agents Increase Prudential Savings themselves • Same is true about Probability of Shock • Optimal Tax Maximal for “Low but not Negligible” Shock Level and Likelihood • Similar results for Debt Ratio Shocks

9. Realistic Debt Maturity Levels • Marginal Ratios of Changes in Debt to Changes in (Collateral) Asset Values, are FAR smaller than the Stock Ratios • Much of Debt is Long-term and Fixed, at least Outside of the Financial sector • Calibration Modified to Reflect Reality • BUT, Modification applied to Baseline!

10. Criticism and Suggestions • Why not do Comprehensive Calibration with Realistic Average & Sectoral Debt Maturity as Applied to Stock Ratio Data • For example, for the Household sector, a Stock Debt Ratio of 50%, and Debt of 10 years in average maturity, less for SME sector. No Equilibrium Multiplicity?

11. Avoid “Straw Man” Critiques • In evaluating YOUR taxes vs Proposed ex post Bailout Funds based on Levies Raised in Boom Times, as an example • NOBODY sensible is proposing levies independent of systemic risk of entities • Don’t Extrapolate Your Results in base case scenarios to ones in where Debt Ratios would be Qualitatively Different!

12. Enrich Structure, Comparison • Assumption that Insider Assets are Not Transferable to Outsiders is too Strong • For alternatives, with Transfers at “Fire Sale” (Outsider Liquidity-constrained) prices, and social costs from Efficiency Losses arising thereby, see papers by • Acharya, Shin, Yorulmazer; Stein 2010

13. Bengui paper on Debt Maturity • More elaborate in considering valuation impact of shocks of long-term (Annuity) debt liabilities, and Productive Assets • Assets Transferable across “Insiders” and Households, having qualitatively different direct productive/utility payoffs • Adds Monitoring Cost of Annuity Debt

14. Result: Differential Taxes • Optimal Pigouvian Taxes on Short-term Debt are Much Lower than it was in the Jeanne-Korinek paper, of the order of around 7% of the quarterly interest rate • Due in part to low-risk (auto-correlated) Income process, CARA Utility based valuations reflecting that, and mitigation of risks via asset sales to households

15. Some Suggestions to Julien B • Explain differences between household utility from holding capital, and Insiders’ production from the same, as aggregate • Equilibrium constrains Total Capital only • Relate especially to Stein (2010) Model • Be more specific about claims such as “First-” (vs “Second-”) Order Difference