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.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 2458-2493 |
| Number of pages | 36 |
| Journal | American Economic Review |
| Volume | 106 |
| Issue number | 9 |
| DOIs | |
| State | Published - Sep 2016 |
Bibliographical note
Funding Information:We thank Manuel Amador, Emmanuel Farhi, Todd Keister, and three referees for detailed comments that led us to rewrite the paper substantially. We also thank Marios Angeletos, Andrew Atkeson, Harold Cole, Harris Dellas, Mikhail Golosov, Guido Lorenzoni, Iván Werning, and Pierre Yared for useful comments, the National Science Foundation for financial support, and Rishabh Kirpalani for research assistance. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. The authors declare that they have no relevant or material financial interests that relate to the research described in this paper.