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TILEC Seminar: Magdalena Rola-Janicka

Date: Time: 10:45 Location: hybrid meeting: Room K1206 and Zoom

The Political Economy of Prudential Regulation

Abstract:

This paper introduces a voting model into a framework with negative borrowing externalities to study voter preferences for prudential regulation. When voting agents account for the general equilibrium impact of prudential policy on future asset prices and consequently, their access to credit. They thus support a universal limit on current debt. Curbing over-borrowing restricts future declines in asset prices, distributing wealth from high- to low-income borrowers, so the former prefer laxer regulation. Political imperfections, such as exemptions of politically connected borrowers, distort the marginal value of regulation. This leads connected borrowers to support excessively strict policy and other agents to vote for overly lax debt limits. If connections and income are correlated, political imperfections may reverse the policy preferences of high- and low-income borrowers.


Summary:

This paper studies equilibrium prudential policy set by a politician appointed through majoritarian elections. In the model a limit on debt is socially optimal, because atomistic borrowers do not internalize how their leverage affects the severity of welfare-reducing fire sales. Falling asset prices reduce welfare of all borrowers by tightening their collateral constraints. However, in the presence of income inequality fire sales have an additional, distributive effect. In particular, high-income borrowers who buy capital from low-income types partially benefit from price drops.

Rational voters understand the impact of prudential policy on asset prices and account for these effects when voting. As a result, if the politician is committed to fair enforcement of regulation, the equilibrium policy is Pareto efficient. The debt limit is laxer than the one preferred by a utilitarian social planner whenever high-income borrowers have a higher electoral influence than the low-income types.

If the enforcement of regulation by the politician is subject to favouritism two distortions alter the policy preferences of borrowers. First, since the policy is less effective borrowers without political connections may prefer a laxer debt limit than under full commitment. Second, politically connected borrowers anticipate exemptions from regulation and thus do not internalize the costs of the debt limit, supporting an inefficiently strict policy. Thus, if connections and impact are correlated the direction of the policy conflict may be reversed: low-income borrowers may now prefer laxer policy than the high-income types.

Speaker: Magdalena Rola-Janicka, Tilburg university


Time: 10:45-11:45 hrs

Host: Konrad Borowicz 

Moderator: Florian Schütt  

* For more information regarding this event please contact M. van Genk ,  24 hours before the event at latest.

** attendance in the room is possible but spaces are limited, please inform M. van Genk ,  24 hours before the event at latest,  should you wish to participate  in the room