On the Destabilizing Effects of Bailouts

Abstract

The destabilizing effects arising from bailout programs can be found in the massive re-allocation of resources that they induce and divert from other uses that, normally, would have a priority. The underlying motivation for a bailout lies in preventing large banks to fail and thus prevent a collapse of the entire banking system. The amount and extent of the bailout depends on: (a) the amount artificial credit created by the entire banking system, induced by the ease of credit and low interest rates imposed by the Central Bank, and (b) the extent of malinvestment induced by the artificial credit expansion.