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Government guarantees and financial stability

Franklin Allen, Elena Carletti, Itay Goldstein and Agnese Leonello

Journal of Economic Theory, 2018, vol. 177, issue C, 518-557

Abstract: Banks are intrinsically fragile because of their role as liquidity providers. This results in under-provision of liquidity. We analyze the effect of government guarantees on the interconnection between banks' liquidity creation and likelihood of runs in a global-game model, where banks' and depositors' behavior are endogenous and affected by the amount and form of guarantee. The main insight of our analysis is that guarantees are welfare improving because they induce banks to improve liquidity provision, although that sometimes increases the likelihood of runs or creates distortions in banks' behavior.

Keywords: Panic runs; Fundamental runs; Government guarantees; Bank moral hazard (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2018
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Working Paper: Government guarantees and financial stability (2017) Downloads
Working Paper: Government Guarantees and Financial Stability (2015) Downloads
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