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Systematic Bailout Guarantees and Tacit Coordination

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Abstract

Both the academic literature and the policy debate on systematic bailout guarantees and Government subsidies have ignored an important effect: in industries where firms may go out of business due to idiosyncratic shocks, Governments may increase the likelihood of (tacit) coordination if they set up schemes that rescue failing firms. In a repeated-game setting, we show that a systematic bailout regime increases the expected profits from coordination and simultaneously raises the probability that competitors will remain in business and will thus be able to “punish” firms that deviate from coordinated behaviour. These effects make tacit coordination easier to sustain and have a detrimental impact on welfare. While the key insight holds across any industry, we study this question with an application to the banking sector, in light of the recent financial crisis and the extensive use of bailout schemes.

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Original languageEnglish
JournalThe B.E. Journal of Economic Analysis & Policy
Volume15
Issue number1
Early online date2 Dec 2014
DOIs
Publication statusPublished - 1 Jan 2015
Peer-reviewedYes

Keywords

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  • competition policy, systematic bailout guarantees, collusion, banking, State aid

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