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The Redistributive Effects of Financial Deregulation

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  • Anton Korinek
  • Jonathan Kreamer

Abstract

Financial regulation is often framed as a question of economic efficiency. This paper, by contrast, puts the distributive implications of financial regulation center stage. We develop a model in which the financial sector benefits from risk-taking by earning greater expected returns. However, risktaking also increases the incidence of large losses that lead to credit crunches and impose negative externalities on the real economy. We describe a Pareto frontier along which different levels of risktaking map into different levels of welfare for the two parties. A regulator has to trade off efficiency in the financial sector, which is aided by deregulation, against efficiency in the real economy, which is aided by tighter regulation and a more stable supply of credit. We also show that financial innovation, asymmetric compensation schemes, concentration in the banking system, and bailout expectations enable or encourage greater risk-taking and allocate greater surplus to the financial sector at the expense of the rest of the economy.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 13/247.

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Length: 42
Date of creation: 17 Dec 2013
Date of revision:
Handle: RePEc:imf:imfwpa:13/247

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Keywords: Financial sector; Banks; Capital; Economic models; bankers; bank capital; bank equity; financial institutions; financial intermediation; financial innovation; financial deregulation; deposit rate; financial system; banking; bank profits; financial intermediaries; stochastic discount factor; financial instability; derivative; banking sector; financial market; financial sector research; bank managers; financial markets; banking regulation; financial risk; banking system; bank failure; risk of credit crunches; banking systems; moral hazard;

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References

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  1. Olivier Jeanne & Anton Korinek, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," NBER Working Papers 16377, National Bureau of Economic Research, Inc.
  2. Brent Neiman, 2013. "The Global Decline of the Labor Share," The Quarterly Journal of Economics, Oxford University Press, vol. 129(1), pages 61-103.
  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, Princeton University Press, edition 1, volume 1, number 8973.
  4. Steven N. Kaplan & Joshua Rauh, 2007. "Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?," NBER Working Papers 13270, National Bureau of Economic Research, Inc.
  5. Guillermo A. Calvo & Fabrizio Coricelli & Pablo Ottonello, 2012. "Labor Market, Financial Crises and Inflation: Jobless and Wageless Recoveries," NBER Working Papers 18480, National Bureau of Economic Research, Inc.
  6. Anton Korinek & Olivier Jeanne, 2013. "Macroprudential Regulation Versus Mopping Up After the Crash," 2013 Meeting Papers, Society for Economic Dynamics 405, Society for Economic Dynamics.
  7. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
  8. Calvo, Guillermo & Coricelli, Fabrizio & Ottonello, Pablo, 2012. "The Labor Market Consequences of Financial Crises With or Without Inflation: Jobless and Wageless Recoveries," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9218, C.E.P.R. Discussion Papers.
  9. Campbell, Jeffrey R. & Hercowitz, Zvi, 2009. "Welfare implications of the transition to high household debt," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(1), pages 1-16, January.
  10. Xavier Freixas & Jean-Charles Rochet, 2008. "Microeconomics of Banking, 2nd Edition," MIT Press Books, The MIT Press, The MIT Press, edition 2, volume 1, number 0262062704, December.
  11. Viral V. Acharya & Tanju Yorulmazer, 2008. "Cash-in-the-Market Pricing and Optimal Resolution of Bank Failures," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 21(6), pages 2705-2742, November.
  12. Anton Korinek & Enrique G. Mendoza, 2013. "From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Implications," NBER Working Papers 19362, National Bureau of Economic Research, Inc.
  13. Gertler, Mark & Kiyotaki, Nobuhiro, 2010. "Financial Intermediation and Credit Policy in Business Cycle Analysis," Handbook of Monetary Economics, Elsevier, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 11, pages 547-599 Elsevier.
  14. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
  15. Thomas Philippon & Ariell Reshef, 2012. "Wages and Human Capital in the U.S. Finance Industry: 1909--2006," The Quarterly Journal of Economics, Oxford University Press, vol. 127(4), pages 1551-1609.
  16. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(1), pages 17-34, January.
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Cited by:
  1. Prasad, Eswar, 2013. "Distributional Effects of Macroeconomic Policy Choices in Emerging Market Economies," IZA Discussion Papers 7777, Institute for the Study of Labor (IZA).

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