Working Paper 730

Efficient Bailouts?

Javier Bianchi | Senior Research Economist

Published January 19, 2016

We develop a quantitative equilibrium model of financial crises to assess the interaction between ex-post interventions in credit markets and the buildup of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. We find that moral hazard effects are limited if bailouts are systemic and broad-based. If bailouts are idiosyncratic and targeted, however, this makes the economy significantly more exposed to financial crises.

Published In: American Economic Review (Vol. 106, No. 12, December 2016, pp. 3607-3659)

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