Abstract
Does wealth inequality make financial crises more likely? If so, how can a government intervene, and how does this affect the distribution of resources in the economy? To answer these questions, we study a banking model where strategic complementarities among wealth-heterogeneous depositors trigger systemic self-fulfilling runs. In equilibrium, higher wealth inequality increases directly the incentives to run of the poor, and indirectly those of the rich via higher bank liquidity insurance, thus increasing the probability of a systemic self-fulfilling run overall. A government intervention on illiquid but solvent banks redistributes resources towards the poor and makes systemic self-fulfilling runs less likely.
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This paper previously circulated as “A Theory of Government Bailouts in a Heterogeneous Banking System”. We would like to thank Mostafa Beshkar, Diana Bonfim, Stephanie Chan, Isabel Correia, Luca Deidda, Robert Deyoung, Itay Goldstein, Hubert Kempf, Agnese Leonello, Luca David Opromolla, Pedro Teles, Harald Uhlig and the seminar participants, among others, at the 8th Lisbon Meetings in Game Theory and Applications, Banco de Portugal, Indiana University, Tilburg University, Maastricht University, ESSEC Business School and University of Bologna for their useful comments. We gratefully acknowledge the financial support from Fundação para a Ciência e Tecnologia, national funding through research Grant UIDB/05069/2020 and Grant PTDC/EGE-IND/31081/2017.
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Garcia, F., Panetti, E. Wealth inequality, systemic financial fragility and government intervention. Econ Theory (2022). https://doi.org/10.1007/s00199-022-01424-6
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DOI: https://doi.org/10.1007/s00199-022-01424-6