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Efficient bailouts?

  • Javier Bianchi

This paper develops a non-linear DSGE model to assess the interaction between ex-post interventions in credit markets and the build-up of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. The optimal policy requires, in general, a mix of ex-post intervention and ex-ante prudential policy. We also analyze the effects of bailouts on financial stability and welfare in the absence of ex-ante prudential policy. Our results show that the moral hazard effects of bailouts are significantly mitigated by making bailouts contingent on the occurrence of a systemic financial crisis.

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File URL: http://www.dallasfed.org/assets/documents/institute/wpapers/2012/0133.pdf
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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 133.

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Date of creation: 2012
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Handle: RePEc:fip:feddgw:133
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