Optimal crisis interventions in an open economy
with credit constraint

Parra-Polanía, Julián Andrés; Vargas-Riaño, Carmiña Ofelia

Optimal crisis interventions in an open economy with credit constraint

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Borradores de Economía; No. 989

Date published

2017-03-27

Date

2018-02-15

Authors

Parra-Polanía, Julián Andrés
Vargas-Riaño, Carmiña Ofelia

Document language

eng

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Las opiniones contenidas en el presente documento son responsabilidad exclusiva de los autores y no comprometen al Banco de la República ni a su Junta Directiva.

The opinions contained in this document are the sole responsibility of the author and do not commit Banco de la República or its Board of Directors.

Abstract

In an open-economy model with collateral constraint, Schmitt-Grohé and Uribe (2016) propose a procyclical policy (it calls for capital controls that are higher during crises than during normal times) that supposedly solves the externality problem that results from the underestimation of the social costs of decentralized debt decisions. We show that such policy does not solve the problem and recall that previous literature has established that a countercyclical tax on debt (positive during normal times and nil during crisis) does. We also show that the externality problem can be solved as well by a countercyclical subsidy on consumption (positive during crises and zero in normal times). The latter result, however, is not a robust policy recommendation because it is not a solution if we remove the assumption that lenders overlook the effect of lump-sum taxes on borrowing capacity.