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Working Paper
Fiscal Multipliers and Financial Crises
What type of fiscal policy is most effective during a financial crisis? I study the macroeconomic effects of the US fiscal policy response to the Great Recession, accounting not only for standard tools such as government purchases and transfers but also for financial sector interventions such as bank recapitalizations and credit guarantees. A nonlinear quantitative model calibrated to the US allows me to study the state-dependent effects of different types of fiscal policies. I combine the model with data on the US fiscal policy response to find that the fall in aggregate consumption would ...
Journal Article
The 1970s Origins of Too Big to Fail
In 1972, bank regulators bailed out the $1.2 billion Bank of the Commonwealth partly because they viewed it as ?too big to fail.? We describe this bailout and subsequent ones through that of Continental Illinois in 1984 and use the descriptions to draw lessons about too-big-to-fail policy. We argue that some of the same issues that motivated bailouts during this earlier period, particularly worries about banking concentration, are relevant today.
Journal Article
The Distributional Effects of Bailouts
This article examines the distributional effects of government bailouts using a heterogeneous agent New Keynesian model with financial intermediation frictions. We analyze government equity injections to financial institutions financed by debt issuance, capturing essential features of bailout policies during financial crises. When calibrated to match key features of the U.S. economy, bailout policies are expansionary and reduce inequality through general equilibrium effects operating primarily via aggregate demand stimulation and increased labor income rather than direct wealth effects. ...
Report
Financial Safety Nets
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 ...
Working Paper
Avoiding Sovereign Default Contagion: A Normative Analysis
Should debtor countries support each other during sovereign debt crises? We answer this question through the lens of a two-country sovereign-default model that we calibrate to the euro-area periphery. First, we look at cross-country bailouts. We find that whenever agents anticipate their existence, bailouts induce moral hazard an reduce welfare. Second, we look at the borrowing choices of a global central borrower. We find that it borrows less than individual governments and, as such, defaults become less frequent and welfare increases. Finally, we show that central borrower's policies can be ...
Working Paper
Efficient Bailouts?
We develop a quantitative equilibrium model of financial crises to assess the interaction between ex-post interventions in credit markets and the buildup of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. We find that moral hazard effects are limited if bailouts are systemic and broad-based. If bailouts are idiosyncratic and targeted, however, this makes the economy significantly ...
Working Paper
Risk-Shifting, Regulation, and Government Assistance
This paper examines an episode when policy response to a financial crisis effectively incentivized financial institutions to reallocate their portfolios toward safe assets. Following a shift to a regime of enhanced regulation and scaled-down public assistance during the savings and loan crisis in 1989, I find that thrifts with a high probability of failure increased their composition of safe assets relative to thrifts with a low probability of failure. The findings also show a shift to safe assets among stock thrifts relative to mutual thrifts, thereby providing evidence of risk-shifting from ...
Working Paper
Optimal Bailouts in Banking and Sovereign Crises
We study optimal bailout policies amidst banking and sovereign crises. Our model features sovereign borrowing with limited commitment, where domestic banks hold government debt and extend credit to the private sector. Bank capital shocks can trigger banking crises, prompting the government to consider extending guarantees over bank assets. This poses a trade-off: Larger bailouts relax financial frictions and increase output, but increase fiscal needs and default risk (creating a ‘diabolic loop’). Optimal bailouts exhibit clear properties. The fraction of banking losses the bailouts cover ...
Working Paper
Unexpected Effects of Bank Bailouts: Depositors Need Not Apply and Need Not Run
A key policy issue is whether bank bailouts weaken or strengthen market discipline. We address this by analyzing how bank bailouts influence deposit quantities and prices of recipients versus other banks. Using the Troubled Asset Relief Program (TARP) bailouts, we find both deposit quantities and prices decline, consistent with substantially reduced demand for deposits by bailed-out banks that dominate market discipline supply effects. Main findings are robust to numerous checks and endogeneity tests. However, diving deeper into depositor heterogeneity suggests nuances. Increases in uninsured ...
Working Paper
Fiscal Multipliers and Financial Crises
I study the effects of the US fiscal policy response to the Great Recession, accounting both for standard tools and financial sector interventions. A nonlinear model calibrated to the US allows me to study the state-dependent effects of different fiscal policies. I combine the model with data on the fiscal policy response to find that the fall in consumption would have been one-third larger in the absence of that response, for a cumulative loss of 7.18%. Transfers and bank recapitalizations yielded the largest fiscal multipliers through new transmission channels that arise from linkages ...