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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 expost 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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Paper provided by Department of Economics - dECON in its series Documentos de Trabajo (working papers) with number 2012.

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Length: 47 pages
Date of creation: Dec 2012
Handle: RePEc:ude:wpaper:2012
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