Runs versus lemons : information disclosure and fiscal capacity

Review of Financial Studies

Economics

Review of Financial Studies 2017 Vol 84:4 p 1683-1707

Faria-e-Castro M; Martinez J; Philippon T

Joseba Martinez

2017

We study the optimal use of disclosure and fiscal backstops during financial crises. Providing information can reduce adverse selection in credit markets, but negative disclosures can also trigger inefficient bank runs. In our model, governments are thus forced to choose between runs and lemons. A fiscal backstop mitigates the cost of runs and allows a government to pursue a high disclosure strategy. Our model explains why governments with strong fiscal positions are more likely to run informative stress tests, and, paradoxically, how they can end up spending less than governments that are more fiscally constrained.

Fiscal policy; Government policy and regulation; Government policy and regulation - Central Banks and their policies

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