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Federal Reserve Bank of Minneapolis
Staff Report
Financial Safety Nets
Julien Bengui
Javier Bianchi
Louphou Coulibaly
Abstract

In this paper, we study the optimal design of financial safety nets under limited private credit. We ask when it is optimal to restrict ex ante the set of investors that can receive public liquidity support ex post. When the government can commit, the optimal safety net covers all investors. Introducing a wedge between identical investors is inefficient. Without commitment, an optimally designed financial safety net covers only a subset of investors. Compared to an economy where all investors are protected, this results in more liquid portfolios, better social insurance, and higher ex ante welfare. Our result can rationalize the prevalent limited coverage of safety nets, such as the lender of last resort facilities.


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Julien Bengui & Javier Bianchi & Louphou Coulibaly, Financial Safety Nets, Federal Reserve Bank of Minneapolis, Staff Report 535, 25 Aug 2016.
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Keywords: Bailouts; Safety nets; Time inconsistency; Public liquidity provision
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