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Optimal Safety Nets

Author

Listed:
  • Louphou Coulibaly

    (University of Montreal)

  • Javier Bianchi

    (Federal Reserve Bank of Minneapolis)

  • Julien Bengui

    (Université de Montréal)

Abstract

We study the optimal design of financial safety nets under limited private credit. When the government can commit about the scope of ex-post public support, the optimal safety net covers all investors. Without commitment, however, the government tends to offer protected investors an ex-post degree of protection that is excessive from an ex-ante perspective. As a result, an optimally designed financial safety net covers only a subset of investors. Compared to an economy where all investors are protected, this results in lower interest rates, better cross-insurance, and higher ex-ante welfare. Our results rationalize the prevalent limited coverage of important public support schemes, such as the lender of last resort facilities.

Suggested Citation

  • Louphou Coulibaly & Javier Bianchi & Julien Bengui, 2016. "Optimal Safety Nets," 2016 Meeting Papers 1571, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1571
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