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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 crisis 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, no 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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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1023.

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Date of creation: Nov 2010
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Handle: RePEc:cep:cepdps:dp1023
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