Should we commit to bailing out the financial system?
Subject
Finance
Publishing details
IFA Working Paper
Authors / Editors
Dow J; Han J
Biographies
Publication Year
2014
Abstract
Existing literature argues that authorities should reduce moral hazard by trying to pre-commit not to bail out, but recognizes that the costs of financial collapse can make bailouts unavoidable ex-post. We find that in the presence of reinforcement between illiquidity and insolvency, a commitment to bail out can have beneficial multiplier effects. The paper concerns a public agency that bails out a government of a distressed country, but the results apply, with minor modifications, to domestic banking crises.
Keywords
Bailout; Commitment; Rescue fund; Financial distress; Sovereign default; Feedback effect
Series
IFA Working Paper