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Ansgar Walther

20 September 2022
WORKING PAPER SERIES - No. 2723
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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.
JEL Code
H23 : Public Economics→Taxation, Subsidies, and Revenue→Externalities, Redistributive Effects, Environmental Taxes and Subsidies
Q58 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Environmental Economics→Government Policy
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
D62 : Microeconomics→Welfare Economics→Externalities
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ECB Lamfalussy Fellowship Programme
20 March 2020
WORKING PAPER SERIES - No. 2380
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Abstract
This paper studies optimal financial policy in a world where the financial sector can become excessively optimistic. I decompose the welfare effects of bank capital regulation to demonstrate the effects of exuberance and its interaction with incentive problems in banking. The optimal policy depends not only on the extent, but also on the type of optimism. For example, it is markedly different when the exuberance of banks focuses on neglected downside risk, as opposed to overstated upside opportunities. A central normative conclusion is that “leaning against the wind”, by tightening capital requirements in exuberant times, can be counterproductive. I show that two natural metrics, describing the distortion in perceived upside and downside risk, are sufficient statistics for the policy implications of exuberance. My results shed light on the diverse empirical evidence on the relationship between bank capital and risk-taking. Finally, I investigate the sensitivity of these insights under different assumptions about government rationality and paternalism.
JEL Code
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G40 : Financial Economics
Network
ECB Lamfalussy Fellowship Programme