Government Bailout Funds: Balancing Rules and Discretion

• Published date: 01 February 2022
• Author: MARK GRADSTEIN
• Date: 01 February 2022
• DOI: http://doi.org/10.1111/jmcb.12788

DOI: 10.1111/jmcb.12788

MARK GRADSTEIN

Government Bailout Funds: Balancing

Rules and Discretion

This paper studies government bailout design in the face of economic fail-

ures by multiple rms, with ensuing threats to economic stability.Assuming

that a commitment to a bailout magnitude is possible, yet cannot be made

contingent on unforeseen circumstances, it is argued that the optimal policy

consists of stipulating a bailout fund whose upper limit cannot be exceeded.

Such an equilibrium policy provides a balance between exibility to adjust

to future circumstances and restraint of moral hazard incentive faced by the

rms. An extension to the baseline model considers the case where corpo-

rate interests, divergent from those of the public, play a role, and the cap on

bailout spending matters for the bargainingoutcome between those interests.

JEL codes: E6, H11

Keywords: political economy, corporate bailouts

T    2007–8 nancial crisis for eco-

nomic stability, in the United States and around the world, inspired discussions of

appropriate regulatory policies to help alleviate crises’ potential adverse effects. In

the aftermath of the crisis, the U.S. government adopted the 2008 Emergency Eco-

nomic Stabilization Act (EESA), which authorized the U.S. Treasury to spend up to

$700 billion on the purchase of distressed assets. This, combined with the subsequent

loan assistance to automakers and other corporate entities, represents the largest gov-

ernment bailout ever.1

The dramatic response to the crisis included an unprecedented bailout of many

hundreds of corporate entities, much of it at taxpayers’ expense. This aroused heated

controversy, and calls mounted to create a more structured and less ad hoc bailout

mechanism to deal with potential future crises. The Dodd–Frank Act of 2010 is an

attempt to improve the regulatory framework in order to prevent and better handle

Veryuseful comments and suggestions of the editor and the referees are gratefully acknowledged.

Department of Economics, Ben Gurion University of the Negev, CEPR, CESifo, and IZA (E-mail:

grade@bgu.ac.il).

Received December 17, 2019; and accepted in revised form November 16, 2020.

1. At least until the 2020 Covid-19 crisis.

Journal of Money, Credit and Banking, Vol. 54, No. 1 (February 2022)

© 2021 The Ohio State University