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http://hdl.handle.net/10419/60925
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| Title: | | Bailouts and financial fragility  |
| Authors: | | Keister, Todd |
| Issue Date: | | 2010 |
| Series/Report no.: | | Staff Report, Federal Reserve Bank of New York 473 |
| Abstract: | | 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. |
| Subjects: | | Bank runs financial regulation |
| JEL: | | E61 G21 G28 |
| Document Type: | | Working Paper |
| Appears in Collections: | | Staff Reports, Federal Reserve Bank of New York
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