A Reinterpretation of the Gordon and Barro Model in Terms of Financial Stability
9 Pages Posted: 16 Aug 2014
Date Written: August 12, 2014
Abstract
A government bailout model based on the framework of time-consistent monetary policy of Barro and Gordon (1983) is developed. In the model, the banking sector and the government play a game where the former chooses a bailout expectation whereas the later reacts by choosing its optimal bailout policy. The banking sector is assumed to be perfectly competitive, aiming only at anticipating the bailout policy. An excess of credit ensues and firms over-invest, which can be amended by an appropriately chosen reserve requirement. The government faces a trade-off between efficiency and stability in trying to minimize the costs of intervention.
Keywords: Government intervention, bailout, real investment
JEL Classification: G1, G2, G3
Suggested Citation: Suggested Citation