The Optimal Bailout Policy in an Interbank Network, Economics Letters, forthcoming.
Abstract: This paper introduces a theoretical model to analyze the optimal bailout policy in an inter-connected banking system. The model intends to highlight two motivations behind providing a partial bailout to banks in distress: prevention of costly bankruptcies and prevention of financial contagion. In the extreme cases where the cost of bailout is sufficiently high or low, the zero-bailout policy and the full-bailout policy is optimal respectively. Otherwise, a partial bailout policy is optimal. The fiscal authority has to balance the benefits of bailouts from bankruptcy and contagion prevention against the cost when it decides on the amount of partial bailout to provide to banks.
Bank Bailouts: Cost of Inability to Commit (Under Review)
Abstract: I develop a theoretical model to investigate the failure to commit in the provision of bailouts to financial institutions. When financial institutions fail, the fiscal authority often deviates from the ex-ante no-bailout commitment as the ex-post best response is bailout. The fiscal authority’s time inconsistency creates moral hazard. I analyze the welfare loss from the failure to commit. In the model, as long as the fiscal authority is able to commit to a pre-determined bailout policy, the outcome is typically constrained efficient. Furthermore, a higher probability of bank run is not always welfare reducing. Increased run probability can be beneficial by making financial institutions more cautious, thus decreasing moral hazard loss. Regulations on short-term interest rates offered by financial institutions can also effectively deter moral hazard, particularly when the run probability is small.
Abstract: This paper uses a theoretical model to analyze the optimal combination of monetary re- sponse and fiscal bailouts in preventing bank failures and financial contagion. I show that the optimal way of rescuing failing banks is to combine a monetary response (lowering of interest rates) with fiscal bailouts. Lower interest rates reduce the size of bailout required to rescue failing banks as they reduce the cost for banks to raise and maintain deposits. The main result of the paper is that banks are willing to monitor their investments more closely when they anticipate a monetary response in case of a bank failure. Additionally, I show that capital requirements such as Basel III do not necessarily incentivize banks to monitor their investments when banks anticipate a monetary response.
Abstract: This paper reinforces a common opinion that bank bailouts create moral hazard by show- ing that bailouts foster excessive risk-taking behavior in banks. However, restricting bailouts altogether is also suboptimal as it forces banks to be overly conservative and forego the benefit that comes from the higher expected returns from risky investments. Therefore, restricting bailouts does not always dominate allowing bailouts and vice versa. However, allowing bailouts can become constrained efficient if implemented together with appropriate Pigouvian taxes. Additionally, if bailout policies can be precommitted ex ante, allowing bailouts can also be constrained efficient. Lastly, the existence of a large bank in the economy can be beneficial or harmful to the economy depending on the size of the large bank.
Abstract: This article introduces an alternative way to introduce topics in production that are commonly taught in introductory economics using a popular mobile game called SimCity BuildIt. The author focuses on the topics of production possibility, opportunity cost, firm production, and cost structure. The article shows how elements in the game can be used to motivate the learning of these topics. Specific examples for each topic can also be generated from the game to be used to introduce the topic and as assignments for students. This allows students to incorporate their gaming experience with learning economics.
Works in Progress:
Predicting Bank Failures Using Recurrent Neural Networks