Bailouts and financial fragility

Arbeitspapier

How does the belief that policymakers will bail out investors in the event of a crisis affect the allocation of resources and the stability of the financial system? I study this question in a model of financial intermediation with limited commitment. When a crisis occurs, the efficient policy response is to use 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: it induces intermediaries to become too liquid from a social point of view and may, in addition, leave the economy more susceptible to a crisis. A policy of taxing short-term liabilities, in contrast, can correct the incentive problem while improving financial stability.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Staff Report ; No. 473

Classification and Topics

• Classification: Wirtschaft ; Policy Objectives; Policy Designs and Consistency; Policy Coordination ; Banks; Depository Institutions; Micro Finance Institutions; Mortgages ; Financial Institutions and Services: Government Policy and Regulation
• Subject: Bank runs ; financial regulation

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Keister, Todd
• Event: Veröffentlichung
• (who): Federal Reserve Bank of New York
• (where): New York, NY
• (when): 2010

Further information

• Handle: http://hdl.handle.net/10419/60925
• Last update: 10.03.2025, 11:41 AM CET