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Financial Stability with Sovereign Debt

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  • Ryuichiro Izumi

    (Department of Economics, Wesleyan University)

Abstract

Are government guarantees or fnancial regulation a more effective way to prevent banking crises? I study this question in the presence of a negative feedback loop between the fscal position of the government and the health of the banking sector. I construct a model of fnancial intermediation in which the government issues, and may default on, debt. Banks hold some of this debt, which ties their health to that of the government. The government's tax revenue, in turn, depends on the quantity of investment that banks are able to fnance. I compare the effectiveness of government guarantees, liquidity regulation, and a combination of these policies in preventing self-fulflling bank runs. In some cases, a combination of the two policies is needed to prevent a run. In other cases, liquidity regulation alone is effective and adding guarantees would make the fnancial system fragile.

Suggested Citation

  • Ryuichiro Izumi, 2020. "Financial Stability with Sovereign Debt," Wesleyan Economics Working Papers 2020-001, Wesleyan University, Department of Economics.
    • Handle: RePEc:wes:weswpa:2020-001
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    2. Chahine, Salim & Chidambaran, N.K., 2023. "Do sovereign-bond issuers learn from peers?," Journal of Financial Stability, Elsevier, vol. 67(C).

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    More about this item

    Keywords

    Bank runs; Sovereign default; Feedback loop; Government guarantees; Liquidity regulation;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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