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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

Available on ECCH

No


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