Dynamic Interventions and Informational Linkages

Abstract

We model a dynamic economy with strategic complementarity among investors and
study how endogenous government interventions mitigate coordination failures. We establish
equilibrium existence and uniqueness, and we show that one intervention can affect
another through altering the public information structure. A stronger initial intervention
helps subsequent interventions through increasing the likelihood of positive
news, but also leads to negative conditional updates. Our results suggest optimal
policy should emphasize initial interventions when coordination outcomes tend to correlate.
Neglecting informational externalities of initial interventions results in over- or
under-interventions. Moreover, saving smaller funds disproportionally more can generate greater informational benefits at smaller costs.

Keywords: Coordination Failures, Government Intervention, Information Design, Financial Crisis, Global Games

JEL Classification: D81, D83, G01, G28, O33