Beyond Pangloss: Financial sector origins of inefficient economic booms

Michael McMahon and Frederic Malherbe

No 15180, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Government guarantees to banks are ubiquitous. We study an equilibrium model where, in the presence of such guarantees, the equilibrium allocation can be characterised as Panglossian: it corresponds to that of a deterministic economy where the best possible state always occurs. However, GDP is inefficiently high and expected consumption inefficiently low. Financial sophistication magnifies this distortion, taking the allocation beyond the Panglossian outcome (i.e. with even higher GDP and even lower expected consumption). We argue that this mechanism is empirically relevant for advanced economies and suggest that the Great Recession, partly, reversed a Great Distortion.

JEL-codes: E22 G28 (search for similar items in EconPapers)
Date: 2020-08
New Economics Papers: this item is included in nep-fdg and nep-mac
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Citations: View citations in EconPapers (1)

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Journal Article: Beyond Pangloss: Financial sector origins of inefficient economic booms (2024)
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