Optimal Safety Nets

Louphou Coulibaly, Javier Bianchi and Julien Bengui

No 1571, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We study the optimal design of financial safety nets under limited private credit. When the government can commit about the scope of ex-post public support, the optimal safety net covers all investors. Without commitment, however, the government tends to offer protected investors an ex-post degree of protection that is excessive from an ex-ante perspective. As a result, an optimally designed financial safety net covers only a subset of investors. Compared to an economy where all investors are protected, this results in lower interest rates, better cross-insurance, and higher ex-ante welfare. Our results rationalize the prevalent limited coverage of important public support schemes, such as the lender of last resort facilities.

Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1571

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