Bailouts, Time Inconsistency, and Optimal Regulation: A Macroeconomic View

Varadarajan Chari and Patrick Kehoe

American Economic Review, 2016, vol. 106, issue 9, 2458-93

Abstract: A common view is that bailouts of firms by governments are needed to cure inefficiencies in private markets. We propose an alternative view: even when private markets are efficient, costly bankruptcies will occur and benevolent governments without commitment will bail out firms to avoid bankruptcy costs. Bailouts then introduce inefficiencies where none had existed. Although granting the government orderly resolution powers which allow it to rewrite private contracts improves on bailout outcomes, regulating leverage and taxing size is needed to achieve the relevant constrained efficient outcome, the sustainably efficient outcome. This outcome respects governments' incentives to intervene when they lack commitment.

JEL-codes: D86 E32 G33 H81 L51 (search for similar items in EconPapers)
Date: 2016
Note: DOI: 10.1257/aer.20150157
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Citations: View citations in EconPapers (72)

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