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Financial Safety Nets

Staff Report 535 | Published August 26, 2016

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Julien Bengui Bank of Canada and CEPR
Javier Bianchi Monetary Advisor
Louphou Coulibaly Research Economist
Financial Safety Nets


In this paper, we study the optimal design of financial safety nets under limited private credit. We ask when it is optimal to restrict ex ante the set of investors that can receive public liquidity support ex post. When the government can commit, the optimal safety net covers all investors. Introducing a wedge between identical investors is inefficient. Without commitment, an optimally designed financial safety net covers only a subset of investors. Compared to an economy where all investors are protected, this results in more liquid portfolios, better social insurance, and higher ex ante welfare. Our result can rationalize the prevalent limited coverage of safety nets, such as the lender of last resort facilities.

Published in: _International Economic Review_ (Vol. 60, No. 1, February 2019, pp. 105-132)