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Inequality and Financial Fragility

Listed author(s):
  • Yuliyan Mitkov

    ()

    (Rutgers University)

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    I study how the distribution of wealth influences the government’s response to a banking crisis and the fragility of the financial system. When the wealth distribution is unequal, the government’s bailout policy during a systemic crisis will be shaped in part by distributional concerns. In particular, government guarantees of deposits will tend to be credible for relatively poor investors, but may not be credible for wealthier investors. As a result, wealthier investors will have a stronger incentive to panic and, in equilibrium, the institutions in which they invest are more likely to experience a run and receive a bailout. Thus, without political frictions and under a government that is both benevolent and utilitarian, bailouts will tend to benefit wealthy investors at the expense of the general public. Rising inequality can strengthen this pattern. In some cases, more progressive taxation reduces financial fragility and can even raise equilibrium welfare for all agents.

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    File URL: http://www.sas.rutgers.edu/virtual/snde/wp/2016-02.pdf
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    Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 201602.

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    Length: 48 pages
    Date of creation: 24 Mar 2016
    Handle: RePEc:rut:rutres:201602
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    1. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
    2. John C. Harsanyi, 1974. "An Equilibrium-Point Interpretation of Stable Sets and a Proposed Alternative Definition," Management Science, INFORMS, vol. 20(11), pages 1472-1495, July.
    3. Chang, Roberto & Velasco, Andres, 2000. "Banks, debt maturity and financial crises," Journal of International Economics, Elsevier, vol. 51(1), pages 169-194, June.
    4. Fitoussi Jean Paul & Saraceno Francesco, 2010. "Europe: How Deep Is a Crisis? Policy Responses and Structural Factors Behind Diverging Performances," Journal of Globalization and Development, De Gruyter, vol. 1(1), pages 1-19, January.
    5. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
    6. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
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