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Managing Financial Crises: Lean or Clean?

Author

Listed:
  • Mitsuru Katagiri

    (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: mitsuru.katagiri@boj.or.jp))

  • Ryo Kato

    (Director, Institute for Monetary and Economic Studies (currently, Research and Statistics Department), Bank of Japan (E-mail: ryou.katou@boj.or.jp))

  • Takayuki Tsuruga

    (Associate Professor, Graduate School of Economics, Kyoto University, (E-mail: tsuruga@econ.kyoto-u.ac.jp))

Abstract

This paper discusses the lean vs. clean policy debate in managing financial crises based on dynamic general equilibrium models with an occasionally binding collateral constraint. We show that a full state-contingent subsidy for debtors can restore the first-best allocations by forestalling disorderly deleveraging in a crisis. While this result appears to favor the clean policy against a lean policy that achieves the second-best allocation, further assessment points to various risks associated with the clean policy from a practical viewpoint. First, the optimal clean policy is likely to call for an unrealistically large amount of fiscal resources. Second, if the clean policy is activated with an empirically realistic intervention, the less-than-optimal clean policy incentivizes debtors to take on undue risks, exposing the economy to higher crisis probabilities. Finally, the less-than-optimal clean policy may give rise to huge welfare losses due to the policy maker's misrecognition of the state of the economy.

Suggested Citation

  • Mitsuru Katagiri & Ryo Kato & Takayuki Tsuruga, 2012. "Managing Financial Crises: Lean or Clean?," IMES Discussion Paper Series 12-E-16, Institute for Monetary and Economic Studies, Bank of Japan.
  • Handle: RePEc:ime:imedps:12-e-16
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    Cited by:

    1. Michael B. Devereux & Eric R. Young & Changhua Yu, 2015. "A New Dilemma: Capital Controls and Monetary Policy in Sudden Stop Economies," NBER Working Papers 21791, National Bureau of Economic Research, Inc.
    2. Kaelo Mpho Ntwaepelo, 2021. "The Effects of Macroprudential and Monetary Policy Shocks in BRICS economies," Economics Discussion Papers em-dp2021-20, Department of Economics, University of Reading.

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    More about this item

    Keywords

    Financial Crisis; Credit Externalities; Bailout; Macroprudential Policy;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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