Expectations vs. fundamentals: Does the cause of banking panics matter for prudential policy?

There is a long-standing debate about whether banking panics and other financial crises always have fundamental causes or are sometimes the result of self-fulfilling beliefs. Disagreement on this point would seem to present a serious obstacle to designing policies that promote financial stability. We show that in some cases the appropriate choice of policy is invariant to the underlying cause of banking panics. We study an environment in which the anticipation of being bailed out in the event of a crisis distorts the incentives of financial institutions and their investors. We compare two policies that aim to correct this distortion: restricting policy makers from engaging in bailouts, and allowing bailouts but taxing the short-term liabilities of financial institutions. We show that the latter policy yields higher equilibrium welfare regardless of whether or not panics are sometimes caused by self-fulfilling beliefs.