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and the 2016 ASSA Meetings. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

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This paper analyzes quantitatively the extent to which there is overborrowing (i.e., inefficient borrowing) in a business cycle model for emerging market economies with production and an occasionally binding credit constraint. The main finding of the analysis is that overborrowing is not a robust feature of this class of model economies: it depends on the structure of the economy and its parametrization. Specifically, we find underborrowing in a production economy with our baseline calibration, but overborrowing with more impatient agents and more volatile shocks. Endowment economies display overborrowing regardless of parameter values, but they do not allow for policy intervention when the constraint binds (in crisis times). Quantitatively, the welfare gains from implementing the constrained-efficient allocation are always larger near crisis times than in normal ones. In production economies, they are one order of magnitude larger than in endowment economies both i n crisis and normal times. This suggests that the scope for economy-wide macro-prudential policy interventions (e.g. prudential taxation of capital flows and capital controls) is weak in this class of models.

In this paper we study whether policy makers should wait to intervene until a financial crisis strikes or rather act in a preemptive manner. We study this question in a relatively simple dynamic stochastic general equilibrium model in which crises are endogenous events induced by the presence of an occasionally binding borrowing constraint as in Mendoza (2010). First, we show that the same set of taxes that replicates the constrained social planner allocation could be used optimally by a Ramsey planner to achieve the first best unconstrained equilibrium: in both cases without any precautionary intervention. Second, we show that the extent to which policymakers should intervene in a preemptive manner depends critically on the set of policy tools available and what these instruments can achieve when a crisis strikes. For example, in the context of our model, we find that, if the policy tools is constrained so that the first best cannot be achieved and the policy make r has access to only one tax instrument, it is always desirable to intervene before the crisis regardless of the instrument used. If however the policy maker has access to two instruments, it is optimal to act only during crisis times. Third and finally, we propose a computational algorithm to solve Markov-Perfect optimal policy for problems in which the policy function is not differentiable.