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Optimal investment taxes and efficient market provision of liquidity in the Diamond-Dybvig model

Author

Listed:
  • Yuzhe Zhang

    (Texas A&M University)

  • Borys Grochulski

    (Federal Reserve Bank of Richmond)

Abstract

We study taxation as an alternative to intermediation in a Diamond-Dybvig economy with a private ex post retrade market and with private ex ante investment. The possibility of private investment imposes an additional constraint on the social planner beyond resource feasibility and incentive compatibility. With this constraint, the simple asset market equilibrium is efficient. If access to private investment is costly, i.e., the private return on the illiquid investment is smaller than the publicly observable return on illiquid investment, then an asset market equilibrium is efficient with investment taxes. An optimal tax system consists of a proportional subsidy to liquid investment and a proportional tax on illiquid investment. In either case, efficiency is attained without intermediation.

Suggested Citation

  • Yuzhe Zhang & Borys Grochulski, 2014. "Optimal investment taxes and efficient market provision of liquidity in the Diamond-Dybvig model," 2014 Meeting Papers 1084, Society for Economic Dynamics.
    • Handle: RePEc:red:sed014:1084
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