European Central Bank
Financial Research Department
Information about this author at RePEc
NBER Working Papers and Publications
|August 2013||Government Debt and Banking Fragility: The Spreading of Strategic Uncertainty|
with Russell Cooper: w19278
This paper studies the interaction of government debt and financial markets. Both markets are fragile: excessively responsive to fundamentals and prone to strategic uncertainty. This interaction, termed a ‘diabolic loop’, is driven by government choice to bail out banks and the resulting incentives for banks to hold government debt rather than to self-insure through equity buffers. We provide conditions such that the ‘diabolic loop’ is a Nash Equilibrium of the interaction between banks and the government. Instability originates in debt markets and is channeled to financial arrangements, and then back again.
The analysis highlights the critical role of bank equity for the existence of a diabolic loop. When equity is issued, no diabolic loop exists. In equilibrium, banks' rational expectat...
|September 2006||Rule-Based Monetary Policy under Central Bank Learning|
with Kosuke Aoki
in NBER International Seminar on Macroeconomics 2004, Richard H. Clarida, Jeffrey Frankel, Francesco Giavazzi and Kenneth D. West, editors