Implicit Government Guarantees

Abstract

Chinese households believe there are certain markets that their government will not, and cannot, allow to fail. I show that these beliefs arise endogenously in a model of financial markets with partial commitment. Partial commitment creates strategic complementarities, where bailouts only occur if a sufficiently high fraction of the population suffers large simultaneous losses. I demonstrate that public financial markets allow households to strategically coordinate and collectively imperil themselves in a manner that compels their government to provide a bailout, thus giving rise to implicit guarantees. Implicit guarantees will be more prevalent in economies where the government has more discretion to intervene.

Keywords: Partial commitment, Financial markets, Strategic complementarities, Political economy, Chinese economy, Financial markets

JEL Classification: G18, P51