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Bailouts and financial fragility

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  • Todd Keister

Abstract

How does the belief that policymakers will bail out investors in the event of a crisis affect the allocation of resources and the stability of the financial system? I study this question in a model of financial intermediation with limited commitment. When a crisis occurs, the efficient policy response is to use public resources to augment the private consumption of those investors facing losses. The anticipation of such a “bailout” distorts ex ante incentives, leading intermediaries to choose arrangements with excessive illiquidity and thereby increasing financial fragility. Prohibiting bailouts is not necessarily desirable, however: it induces intermediaries to become too liquid from a social point of view and may, in addition, leave the economy more susceptible to a crisis. A policy of taxing short-term liabilities, in contrast, can correct the incentive problem while improving financial stability.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 473.

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Date of creation: 2010
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Handle: RePEc:fip:fednsr:473

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Related research

Keywords: Intermediation (Finance) ; Financial crises ; Liquidity (Economics) ; Taxation ; Business failures;

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References

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  1. Huberto M. Ennis & Todd Keister, 2007. "Bank runs and institutions : the perils of intervention," Working Paper 07-02, Federal Reserve Bank of Richmond.
  2. Friederike Niepmann & Tim Schmidt-Eisenlohr, 2011. "Bank Bailouts, International Linkages and Cooperation," CESifo Working Paper Series 3384, CESifo Group Munich.
  3. Edward J. Green, 1995. "Implementing Efficient Allocations in a Model of Financial Intermediation," Meeting papers 9506001, EconWPA.
  4. Ennis, Huberto M. & Keister, Todd, 2009. "Run equilibria in the Green-Lin model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 144(5), pages 1996-2020, September.
  5. Ennis, Huberto M. & Keister, Todd, 2010. "Banking panics and policy responses," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 404-419, May.
  6. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.
  7. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
  8. Carlsson, H. & Damme, E.E.C. van, 1990. "Global games and equilibrium selection," Discussion Paper 1990-52, Tilburg University, Center for Economic Research.
  9. Emmanuel Farhi & Jean Tirole, 2009. "Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts," NBER Working Papers 15138, National Bureau of Economic Research, Inc.
  10. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  11. Acharya, Viral V. & Yorulmazer, Tanju, 2007. "Too many to fail--An analysis of time-inconsistency in bank closure policies," Journal of Financial Intermediation, Elsevier, vol. 16(1), pages 1-31, January.
  12. Manuelli, Rodolfo & Peck, James, 1992. "Sunspot-like effects of random endowments," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 193-206, April.
  13. Antoine Martin, 2001. "Liquidity provision vs. deposit insurance : preventing bank panics without moral hazard?," Research Working Paper RWP 01-05, Federal Reserve Bank of Kansas City.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Dealing with debt, financial regulation, and the lender of last resort
    by Matt Nolan in TVHE on 2012-10-01 19:00:26
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Raquel de F. Oliveira & Rafael F. Schiozer & Lucas A. B. de C. Barros, 2011. "Too Big to Fail Perception by Depositors: an empirical investigation," Working Papers Series 233, Central Bank of Brazil, Research Department.
  2. Fredric Mishkin, 2011. "How Should Central Banks Respond to Asset-Price Bubbles? The 'Lean' versus 'Clean' Debate After the GFC," RBA Bulletin, Reserve Bank of Australia, pages 59-70, June.
  3. Keiichiro Kobayashi & Tomoyuki Nakajima, 2014. "A macroeconomic model of liquidity crises," KIER Working Papers 876, Kyoto University, Institute of Economic Research.
  4. V.V. Chari & Patrick J. Kehoe, 2013. "Bailouts, time inconsistency, and optimal regulation," Staff Report 481, Federal Reserve Bank of Minneapolis.
  5. Joon-Ho Hahm & Frederic S. Mishkin & Hyun Song Shin & Kwanho Shin, 2012. "Macroprudential Policies in Open Emerging Economies," NBER Working Papers 17780, National Bureau of Economic Research, Inc.
  6. Javier Bianchi, 2012. "Efficient Bailouts?," NBER Working Papers 18587, National Bureau of Economic Research, Inc.
  7. Jaromir Nosal & Guillermo Ordoñez, 2013. "Uncertainty as Commitment," NBER Working Papers 18766, National Bureau of Economic Research, Inc.
  8. Todd Keister & Vijay Narasiman, 2011. "Expectations versus fundamentals: does the cause of banking panics matter for prudential policy?," Staff Reports 519, Federal Reserve Bank of New York.
  9. Frederic S. Mishkin, 2011. "Monetary Policy Strategy: Lessons from the Crisis," NBER Working Papers 16755, National Bureau of Economic Research, Inc.
  10. Wang, Chunyang, 2013. "Bailouts and bank runs: Theory and evidence from TARP," European Economic Review, Elsevier, vol. 64(C), pages 169-180.
  11. Itay Goldstein & Assaf Razin, 2013. "Three Branches of Theories of Financial Crises," NBER Working Papers 18670, National Bureau of Economic Research, Inc.
  12. Franklin Allen & Elena Carletti & Agnese Leonello, 2011. "Deposit insurance and risk taking," Oxford Review of Economic Policy, Oxford University Press, vol. 27(3), pages 464-478.

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