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How a Bank Bailout may Increase Systemic Risk

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  • Victoria Miller

Abstract

In 2008--2009, the US government spent trillions of dollars to bailout its financial system and prevent insolvency due to a deterioration in domestic loan portfolios. The following dips in US bond prices suggest that global investors feared that the US was over-extending itself and might be unable to repay its debt with taxes rather than inflation. The paper illustrates that if uncertainty arises about a large government's ability to raise taxes to repay its debt, then a debt-financed bailout which initially restores bank health may inadvertently contribute to the financial system's ultimate demise if banks are important lenders to a foreign country that pegs its currency to the domestic money.

Suggested Citation

  • Victoria Miller, 2012. "How a Bank Bailout may Increase Systemic Risk," International Economic Journal, Taylor & Francis Journals, vol. 26(4), pages 541-546, June.
    • Handle: RePEc:taf:intecj:v:26:y:2012:i:4:p:541-546
    DOI: 10.1080/10168737.2011.616521
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    References listed on IDEAS

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    1. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2004. "Government guarantees and self-fulfilling speculative attacks," Journal of Economic Theory, Elsevier, vol. 119(1), pages 31-63, November.
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    3. Gary Gorton & Lixin Huang, 2004. "Liquidity, Efficiency, and Bank Bailouts," American Economic Review, American Economic Association, vol. 94(3), pages 455-483, June.
    4. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, vol. 45(7), pages 1151-1193.
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