Can Good Events Lead to Bad Outcomes? Endogenous Banking Crises and Fiscal Policy Responses
IMF Working Papers, November 1, 2006
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- Can Good Events Lead to Bad Outcomes? Endogenous Banking Crises and Fiscal Policy Responses
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Bibliographic details
- Authors: Celine Rochon, Andrew Feltenstein
- Published: November 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451865233.001
Research question and approach
- Investigates the impact of labor market restructuring and foreign direct investment on the banking sector.
- Uses a dynamic general equilibrium model with a financial sector.
- Numerical simulations are performed using stylized Chinese data.
- Compares scenarios that generate bank failures with a benchmark scenario in which banks remain solvent.
Key simulated triggers of bank failures
- Increases in the growth rate of the labor force.
- A revaluation of the exchange rate.
- An increase in debt issue to finance the government deficit.
- These events can originate from apparently beneficial economic trends or from correct monetary and fiscal policies.
Fiscal policy interventions analyzed
- Fiscal policies that modify relative factor prices:
- Lowering the capital tax rate.
- Increasing the tax rate on labor.
- Mechanism: such policies raise the return to capital and can prevent banking failures.
Welfare and short-run effects
- The fiscal policies that prevent banking failures are, in the short run, welfare reducing.
Subject areas and keywords
- Subject: Banking, Budget planning and preparation, Distressed institutions, Foreign direct investment, Government debt management
- Keywords: cost of capital, rate of return, WP