Prudential capital controls or bailouts? The impact of different collateral constraint assumptions

The literature on small open-economy models with collateral constraints has provided the theoretical grounds for macroprudential regulations. This paper examines a subsidy on debt during a crisis as a form of bailout in comparison with prudential capital controls. We show that the policy prescription on bailouts differs substantially between the timing assumptions of the collateral constraint of households. If borrowing is constrained by the value of assets that households have purchased before they borrow, the bailout is neutral, suggesting that prudential capital controls are preferable. If, on the other hand, households collateralize their assets that they purchase at the same time as their borrowing, the bailout replicates the unconstrained allocation without collateral constraint and outperforms prudential capital controls. Even in the latter case, however, our numerical experiments suggest that such bailouts restoring the unconstrained allocation may not be implementable in terms of its size and frequency.