Abstract: We study strategic environments involving negative externalities, such as excessive risk-taking by banks or overuse of groundwater by farmers, 

where Pigouvian taxes are implemented to restore efficiency. Agents face uncertainty, receive noisy signals, and overweight recent information relative to rational agents. We characterize the optimal Pigouvian tax and study how the social planner should respond after observing a new signal. A response is only needed when agents deviate from rational expectations. Interestingly, the direction of this response critically depends on belief heterogeneity: when all agents share a common belief, the planner should increase the tax rate after observing a favorable signal; by contrast, when beliefs are heterogeneous, she should decrease the tax rate.

Presentations: IMF, Kelley