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Bailouts and Financial Fragility

  • Todd Keister

    ()

    (Rutgers University)

Should policy makers be prevented from bailing out investors in the event of a crisis? I study this question in a model of financial intermediation with limited commitment. When a crisis occurs, the policy maker will respond by using public resources to augment the private consumption of those investors facing losses. The anticipation of such a “bailout” distorts ex ante incentives, leading intermediaries to choose arrangements with excessive illiquidity and thereby increasing financial fragility. Prohibiting bailouts is not necessarily desirable, however: while it induces intermediaries to become more liquid, it may nevertheless lower welfare and leave the economy more susceptible to a crisis. A policy of taxing short-term liabilities, in contrast, can both improve the allocation of resources and promote financial stability.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 201401.

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Length: 20 pages
Date of creation: 29 Jan 2014
Date of revision:
Handle: RePEc:rut:rutres:201401
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  1. Emmanuel Farhi & Jean Tirole, 2009. "Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts," NBER Working Papers 15138, National Bureau of Economic Research, Inc.
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  13. David Andolfatto & Ed Nosal & Neil Wallace, 2006. "The role of independence in the Green-Lin Diamond-Dybvig model," Working Paper 0615, Federal Reserve Bank of Cleveland.
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  17. Huberto M. Ennis & Todd Keister, 2009. "Bank Runs and Institutions: The Perils of Intervention," American Economic Review, American Economic Association, vol. 99(4), pages 1588-1607, September.
  18. repec:ner:tilbur:urn:nbn:nl:ui:12-154416 is not listed on IDEAS
  19. Gale, Douglas & Vives, Xavier, 2002. "Dollarization, bailouts, and the stability of the banking system," HWWA Discussion Papers 185, Hamburg Institute of International Economics (HWWA).
  20. Ennis, Huberto M. & Keister, Todd, 2009. "Run equilibria in the Green-Lin model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 144(5), pages 1996-2020, September.
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  25. Jaromir Nosal & Guillermo Ordoñez, 2013. "Uncertainty as commitment," National Bank of Poland Working Papers 141, National Bank of Poland, Economic Institute.
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  28. John H. Boyd & Chun Chang & Bruce D. Smith, 1998. "Deposit insurance: a reconsideration," Working Papers 593, Federal Reserve Bank of Minneapolis.
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