Can Good Events Lead to Bad Outcomes? Endogenous Banking Crises and Fiscal Policy Responses

 
Author/Editor: Feltenstein, Andrew ; Rochon, Céline
 
Publication Date: November 01, 2006
 
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Summary: In this paper, we study the impact of labor market restructuring and foreign direct investment on the banking sector, using a dynamic general equilibrium model with a financial sector. Numerical simulations are performed using stylized Chinese data, and banks failures are generated through increases in the growth rate of the labor force, a revaluation of the exchange rate or an increase in debt issue to finance the government deficit, as compared to a benchmark scenario in which banks remain solvent. Thus bank failures can result from what might seem to be either beneficial economic trends, or correct monetary and fiscal policies. We introduce fiscal policies that modify relative factor prices by lowering the capital tax rate and increasing the tax rate on labor. Such policies can prevent banking failures by raising the return to capital. It is shown that such fiscal policies are, in the short run, welfare reducing.
 
Series: Working Paper No. 06/263
Subject(s): Banking | China | Fiscal policy | Tax rates | Labor markets | Foreign investment | Economic models | China, People's Republic of

Author's Keyword(s): Banking failures | fiscal policies
 
English
Publication Date: November 01, 2006
ISBN/ISSN: 1934-7073 Format: Paper
Stock No: WPIEA2006263 Pages: 26
Price:
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