Flight to Quality and Bailouts: Policy Remarks and a Literature Review
Ricardo J. Caballero
Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)
Pablo D. Kurlat
Stanford University - Department of Economics
October 9, 2008
MIT Department of Economics Working Paper No. 08-21
Flight to quality episodes involve a combination of extreme risk- or uncertainty-aversion, weaknesses in the balance sheets of key financial intermediaries, and strategic or speculative behavior, that increases credit spreads on all but the safest and most liquid assets. Unlike previous episodes, the entire U.S. financial system is currently at the center of the trouble, with no safe haven pockets, which may lead to greater real effects. The U.S. government's credit is still impeccable, which facilitates policies in support of the financial system. Policy must take into account incentives for behavior during the crisis, discouraging excessive prudence, which sometimes implies relegating post-crisis moral hazard concerns to a secondary role.
Number of Pages in PDF File: 27
Keywords: subprime crisis, liquidity, bailout, intermediation, credit spreads
JEL Classification: E44, G14, G21
Date posted: November 9, 2008
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