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Bank Bailouts, International Linkages, and Cooperation

  • Friederike Niepmann
  • Tim Schmidt-Eisenlohr

Financial institutions are increasingly linked internationally. As a result, financial crises and government intervention have stronger effects beyond borders. We provide a model of international contagion allowing for bank bailouts. While a social planner trades off tax distortions, liquidation losses, and intra- and intercountry income inequality, in the noncooperative game between governments there are inefficiencies due to externalities, a lack of burden sharing, and free riding. We show that, in absence of cooperation, stronger interbank linkages make government interests diverge, whereas cross-border asset holdings tend to align them. We analyze different forms of cooperation and their effects on global and national welfare.

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Article provided by American Economic Association in its journal American Economic Journal: Economic Policy.

Volume (Year): 5 (2013)
Issue (Month): 4 (November)
Pages: 270-305

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Handle: RePEc:aea:aejpol:v:5:y:2013:i:4:p:270-305
Note: DOI: 10.1257/pol.5.4.270
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