Corrective Regulation with Imperfect Instruments

67 Pages Posted: 2 Sep 2021

See all articles by Eduardo Davila

Eduardo Davila

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Ansgar Walther

Imperial College London; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: August 10, 2021

Abstract

This paper studies the optimal design of second-best corrective regulation, when some agents or 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 the optimal second-best policy is determined by a subset of policy elasticities: leakage elasticities, and characterize the marginal value of relaxing regulatory constraints. We apply our results to scenarios with unregulated agents/activities and with uniform regulation across agents/activities. We illustrate our results in applications to shadow banking, scale-invariant regulation, asset substitution, and fire sales.

Keywords: corrective regulation, second-best policy, Pigouvian taxation, policy elasticities, leakage elasticities, regulatory arbitrage, financial regulation

JEL Classification: G18, G28, H21, D62

Suggested Citation

Davila, Eduardo and Walther, Ansgar, Corrective Regulation with Imperfect Instruments (August 10, 2021). Available at SSRN: https://ssrn.com/abstract=3902824 or http://dx.doi.org/10.2139/ssrn.3902824

Eduardo Davila

Yale University - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ansgar Walther (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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