Showing papers by "Jean Tirole published in 2012"

Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts †

Abstract: The paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy. When everyone engages in maturity transformation, authorities haver little choice but facilitating refinancing. In turn, refusing to adopt a risky balance sheet lowers the return on equity. The key ingredient is that monetary policy is non-targeted. The ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage, while the distortion costs are to a large extent fixed. This insight has important consequences. First, banks choose to correlate their risk exposures. Second, private borrowers may deliberately choose to increase their interest-rate sensitivity following bad news about future needs for liquidity. Third, optimal monetary policy is time inconsistent. Fourth, macro-prudential supervision is called for. We characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets. We establish the robustness of our insights when the set of

Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning

Abstract: As illustrated by liquidity support, equity injections and asset repurchases in financial crises and by IMF credit lines to countries, authorities often intervene in orderto revive markets that have dried up or to create newones. In suchsituations, agents participate only if they receive from the governmental scheme more than in the marketplace, while the market outcome depends on who joins the scheme. The paper provides a first analysis of market jumpstarting and its two-way interaction between mechanism design and participation constraints. In the model, sellers in need of cash have private information about the value of their legacy asset. The absence of buyer confidence forces authorities to intervene to jump-start the market. We characterize the optimal intervention, and draw two main implications. First, the government should clean up the market, through buybacks of the weakest assets and then through some equity injections, and leave the agents with the strongest legacy assets to the market. In particular, authorities should not substitute fully for the market, even when they have no comparative disadvantage in acquiring assets or shares thereof. Second, the government creates its own competition by cleaning up the market from its most toxic pieces. At the optimal intervention the government always strictly overpays for the legacy asset. Yet, and unlike what would be suggested by Coasian profit evasion, the existence of a later market imposes no welfare cost. While it is cast in a public intervention context, the analysis of mechanismdependent reservation utilities also admits important private sector applications.

Macroeconomic Shocks and Banking Regulation

Abstract: The recent crisis has brought to the fore the cyclical properties of banking regulation. Countercyclical buffers and enhanced capital requirements meant to stabilize banks' balance sheets across the cycle are not costless, and a delicate balance needs to be reached between providing incentives to generate value and discouraging excessive risk-taking. The paper develops a model in which, in contrast with Modigliani-Miller, outside equity and capital requirements matter. It analyses banking regulation in the presence of macroeconomic shocks and studies the desirability of self-insurance mechanisms such as countercyclical capital buffers or dynamic provisioning, as well as "macro-hedges" such as CoCos and capital insurance.

Market Power Screens Willingness-to-Pay*

Abstract: What is the best way to reward innovation? While prizes avoid deadweight loss, intellectual property selects high social surplus projects. Optimal innovation policy thus trades off the ex-ante screening benefit and the ex-post distortion. It solves a multidimensional screening problem in the private information held by the innovator: research cost, quality and market size of the innovation. The appropriate degree of market power is never full monopoly pricing and is determined by measurable market characteristics, the inequality and elasticity of innovation supply, making the analysis open to empirical calibration. The framework has applications beyond IP policy to the optimal pricing of platforms or the optimal procurement of public infrastructure.

Laws and Norms

Abstract: This paper analyzes how private decisions and public policies are shaped by personal and societal preferences ("values"), material or other explicit incentives ("laws") and social sanctions or rewards ("norms"). It first examines how honor, stigma and social norms arise from individuals' behaviors and inferences, and how they interact with material incentives. It then characterizes optimal incentive-setting in the presence of norms, deriving in particular appropriately modified versions of Pigou and Ramsey taxation. Incorporating agents' imperfect knowledge of the distribution of preferences opens up to analysis several new questions. The first is social psychologists' practice of "norms-based interventions", namely campaigns and messages that seek to alter people's perceptions of what constitutes "normal" behavior or values among their peers. The model makes clear how such interventions operate, but also how their effectiveness is limited by a credibility problem, particularly when the descriptive and prescriptive norms conflict. The next main question is the expressive role of law. The choices of legislators and other principals naturally reflect their knowledge of societal preferences, and these same "community standards" are also what shapes social judgements and moral sentiments. Setting law thus means both imposing material incentives and sending a message about society's values, and hence about the norms that different behaviors are likely to encounter. The analysis, combining an informed principal with individually signaling agents, makes precise the notion of expressive law, determining in particular when a weakening or a strengthening of incentives is called for. Pushing further this logic, the paper also sheds light on why societies are often resistant to the message of economists, as well as on why they renounce certain policies, such as "cruel and unusual punishments", irrespective of effectiveness considerations, in order to express their being "civilized".

Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises

Abstract: Classic analyses of sovereign debt make no predictions concerning the allocation of risk between the market and the official sector or among official sector creditors. To open the black box of the composition of a sovereign's foreign liabilities, this paper develops a new framework and distinguishes between ``ex-post solidarity'', aimed at avoiding collateral damages inflicted by a distressed country's default, and ``contractual solidarity'', illustrated by joint-and-several liability or lines of credit, that creates formal modes of insurance. When countries differ substantially in their probability of distress, the optimal mechanism takes the form of a debt brake together with mixed public-private financing for the weaker country; no joint liability emerges. By contrast, in a more symmetrical, mutual-insurance context, contractual solidarity in the form of joint liability is optimal provided that country shocks are sufficiently independent and spillovers costs sufficiently large relative to default costs. Joint liability increases both borrowing capability and the risk of contagion. Spillovers, when endogenized, are larger under mutual insurance than under one-way insurance. Finally, the paper considers the possibility of debt monetization, comparing the outcomes under a currency union and an own currency. It studies whether a currency area is more conducive to bailouts and whether bailouts are optimally denominated in domestic or foreign currency.

The euro crisis: some refl exions on institutional reform

Abstract: The debate on the euro crisis understandably has had a strong short-term focus. Avoiding short-term disaster has been tantamount and the long-term sustainability issue sometimes neglected; yet, the institutional failure of the euro area forces us to reconsider current arrangements in order to restore credibility and sustainability. The article discusses various paths for the reform of the overall governance, from fi scal management to banking regulation, through the recent proposals to mutualise and repackage part of the sovereign debts into a supranational one or to introduce joint-and-several liability.

“Information,Tranching and Liquidity”

Abstract: The paper revisits and qualifies existing insights on security design. A rich literature argues that tranching creates debt-like instruments that are robust to adverse selection or discourage wasteful information acquisition. Yet, for a given information structure, while tranching confines and liquefies the safe part of a cash flow (the insulation effect), bundling makes the risky part more liquid (the trading adjuvant effect). Moreover, tranching always has adverse welfare effects on information acquisition: It encourages (discourages) information acquisition when it should be deterred (encouraged). The paper provides conditions under which tranching reduces welfare even when the insulation effect dominates the trading adjuvant effect. The paper’s second contribution is to analyze the velocity of assets that are repeatedly traded. The dynamic model can be nested into the static one and insights are shown to be closely related to those on tranching. The central insight is that liquidity is self-fulfilling: A perception of future illiquidity creates current illiquidity.

Market Power Screens Willingness-to-Pay

Abstract: What is the best way to reward innovation? While prizes avoid deadweight loss, intellectual property selects high social surplus projects. Optimal innovation policy thus trades off the ex-ante screening benefit and the ex-post distortion. It solves a multidimensional screening problem in the private information held by the innovator: research cost, quality and market size of the innovation. The appropriate degree of market power is never full monopoly pricing and is determined by measurable market characteristics, the inequality and elasticity of innovation supply, making the analysis open to empirical calibration. The framework has applications beyond IP policy to the optimal pricing of platforms or the optimal procurement of public infrastructure.

Preventing and resolving banking and sovereign crises: toward a new institutional framework

Abstract: Weak European institutions bear some responsibility for the current Eurozone crisis. The paper discusses various alleys for reforming European institutions, such as those in charge of monitoring countries and banks. It then discusses the future of solidarity within the Eurozone, as well as proposed reforms impacting risk sharing. It concludes with steps that might help restore confidence in the European Monetary Union