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Forbearance Impedes Confidence Recovery (Revised)

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Keiichiro KOBAYASHI

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Abstract

This paper is a revised version of DP02-E-005, where the mathematical structure of the model in this paper is substantially different from the previous one. The finding that countries that take a slow approach to reform during a financial crisis run into problems of persistent stagnation is usually explained as follows: Forbearance policy (i.e., an implicit subsidy to inefficient sectors) distorts resource allocation, causing a supply shortage of resources to the productive sectors. I propose another explanation: Forbearance impedes the recovery of confidence that is lost during a financial crisis. If confidence is restored through Bayesian learning by economic agents based on observations of government actions, then the inaction of the government (forbearance) impedes Bayesian learning. The model shows that forbearance policy delays economic recovery. (forthcoming in Journal of Macroeconomics)

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Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 05002.

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Length: 18 pages
Date of creation: Feb 2005
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Handle: RePEc:eti:dpaper:05002

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  1. Barro, Robert J., 1986. "Reputation in a model of monetary policy with incomplete information," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 3-20, January. [Downloadable!] (restricted)
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  2. Fernandez, Raquel & Rodrik, Dani, 1991. "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty," American Economic Review, American Economic Association, vol. 81(5), pages 1146-55, December. [Downloadable!] (restricted)
  3. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April. [Downloadable!] (restricted)
  4. Stephen Morris, 1996. "Speculative investor behavior and learning," Working Papers 96-5, Federal Reserve Bank of Philadelphia. [Downloadable!]
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  5. Alesina, A. & Drazen, A., 1991. "Why Are Stabilizations Delayed?," Papers 6-91, Tel Aviv - the Sackler Institute of Economic Studies.
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  6. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Blackwell Publishing, vol. 52(4), pages 647-63, October. [Downloadable!] (restricted)
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