SOURCE: Federal Reserve Bank of Richmond

May 31, 2005 15:49 ET

Richmond Fed's Economic Quarterly Features New Thoughts on Too-Big-to-Fail Banking Policy

RICHMOND, VA -- (MARKET WIRE) -- May 31, 2005 -- Bank Risk of Failure and the Too-Big-to-Fail Policy. The possibility that large banks may have access to contingent government bailouts creates a risk and a size distortion in their decisions: banks tend to become riskier and larger, asserts Richmond Fed economist Huberto M. Ennis and research associate H. M. Malek. While the cost of the too-big-to-fail distortions could be high, the available evidence of their importance in the U.S. economy is inconclusive. Any proposal for policy reform should weigh this empirical limitation, according to the article.

Also in the Spring 2005 issue:

Equilibrium Models of Personal Bankruptcy: A Survey. A growing literature analyzing the default of household debt through bankruptcy harbors three lessons, observes Richmond Fed economist Kartik Athreya. First, for bankruptcy to be welfare-improving, catastrophic income risk must be an important facet of economic life. Second, moral hazard can completely undo the benefits of generous default. Third, bankruptcy must be studied jointly with insurance schemes in general.

What Difference Would an Inflation Target Make? Critics of an explicit inflation target argue that it would require additional fluctuations in real output and unemployment. However, Richmond Fed economist Robert L. Hetzel argues that theory and practice have shown this alleged dilemma to be a false one. However, an inflation target, he claims, would demand more communication by the Fed.

Limited Participation and the Neutrality of Money. Stephen D. Williamson, Chester A. Phillips Professor of Financial Economics at the University of Iowa and Visiting Scholar at the Richmond Fed, explores limited participation models of money and asserts that actions by the central bank redistribute wealth among economic agents. This class of models was developed in the early 1980s and has played an important role in recent macroeconomic research. Wealth redistribution stemming from limited participation has important implications for the effects of monetary policy on the economy and for how monetary policy should be conducted.

The Economic Quarterly is a free publication containing economic analysis pertinent to Federal Reserve monetary and banking policy. For free copies or more information, contact the Federal Reserve Bank of Richmond's Public Affairs office at (804) 697-7982. The articles are available online at http://www.rich.frb.org/publications/economic_research/economic_quarterly/index.cfm

Contact Information

  • Contact:
    John Weinberg, Director of Research
    Federal Reserve Bank of Richmond
    804-697-8205

    Jennifer Sparger, Research/Publications Unit
    Jennifer.Sparger@rich.frb.org
    804-697-8148