Selloffs, Bailouts, and Feedback: Can Asset Markets Inform Policy

We present a model in which a policymaker observes trade in a financial asset before deciding whether to intervene in the economy, for example by offering a bailout or monetary stimulus. Because an intervention erodes the value of private information, informed investors are reluctant to take short positions and selloffs are, therefore, less likely and less informative. The policymaker faces a tradeoff between eliciting information from the asset market and using the information so obtained. In general she can elicit more information if she commits to intervene only infrequently. She thus may benefit from imperfections in the intervention process or from being non-transparent about the costs or benefits of intervention.