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Flight to Quality and Bailouts: Policy Remarks and a Literature Review

27 Pages Posted: 9 Nov 2008  

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

Date Written: October 9, 2008

Abstract

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.

Keywords: subprime crisis, liquidity, bailout, intermediation, credit spreads

JEL Classification: E44, G14, G21

Suggested Citation

Caballero, Ricardo J. and Kurlat, Pablo D., Flight to Quality and Bailouts: Policy Remarks and a Literature Review (October 9, 2008). MIT Department of Economics Working Paper No. 08-21. Available at SSRN: https://ssrn.com/abstract=1297456 or http://dx.doi.org/10.2139/ssrn.1297456

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Building E52-528
Cambridge, MA 02142
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617-253-0489 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pablo D. Kurlat

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

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