Wealth inequality, systemic financial fragility and government intervention

Abstract

AbstractDoes wealth inequality make financial crises more likely? If so, how can a government intervene, and how does this affect the distribution of resources in the economy? To answer these questions, we study a banking model where strategic complementarities among wealth-heterogeneous depositors trigger systemic self-fulfilling runs. In equilibrium, higher wealth inequality increases directly the incentives to run of the poor, and indirectly those of the rich via higher bank liquidity insurance, thus increasing the probability of a systemic self-fulfilling run overall. A government intervention on illiquid but solvent banks redistributes resources towards the poor and makes systemic self-fulfilling runs less likely.