Working Paper: NBER ID: w22594
Authors: 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.
Keywords: financial safety nets; liquidity support; public liquidity provision; moral hazard
JEL Codes: E58; E61; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government commitment (H81) | optimal safety net covers all investors (G23) |
| optimal safety net covers all investors (G23) | efficient allocations (D61) |
| lack of government commitment (H11) | excessive liquidity provision to protected investors (G28) |
| excessive liquidity provision to protected investors (G28) | moral hazard and inefficiencies (D61) |
| protected agents investing in illiquid portfolios (G23) | high interest rate on public debt (H63) |
| high interest rate on public debt (H63) | adverse effects on unprotected investors (G18) |
| lack of commitment (J22) | optimal safety net includes only a subset of investors (G11) |
| optimal safety net includes only a subset of investors (G11) | better liquidity management (G33) |
| better liquidity management (G33) | higher ex ante welfare (D69) |
| expanding the safety net (H53) | underinvestment in liquid assets (G31) |