Bailouts
Edward Green
Economic Quarterly, 2010, vol. 96, issue 1Q, 11-32
Abstract:
Despite the cogent criticism that \\"bailing out\\" insolvent firms creates moral hazard, bailouts often occur in the aftermath of bank runs and other financial crises. In an environment where it is economically efficient to make illiquid investments, and where investors have private information regarding their respective liquidity risks, the investment contract must satisfy an incentive constraint. Limited liability tightens this constraint under laissez faire. In principle, government bailouts of insolvent firms might undo this adverse effect of limited liability. A theoretical example is constructed in which bailing out an insolvent corporate sector in some states of the world is essential to implementing efficient investment in a limited-liability regime. This example illustrates the beneficial constraint-relaxation effect of a bailout but abstracts from the moral hazard problem against which it must be weighed.
Keywords: Inflation (Finance); Moral hazard; Financial institutions; Monetary policy (search for similar items in EconPapers)
Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations:
Downloads: (external link)
https://www.richmondfed.org/-/media/RichmondFedOrg ... 010/q1/pdf/green.pdf Full Text (text/html)
Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
HTML/Text
Persistent link: https://EconPapers.repec.org/RePEc:fip:fedreq:y:2010:i:1q:p:11-32:n:v.96no.1
Ordering information: This journal article can be ordered from
Access Statistics for this article
More articles in Economic Quarterly from Federal Reserve Bank of Richmond Contact information at EDIRC.
Bibliographic data for series maintained by Christian Pascasio ().