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Title: Beyond Pangloss: Financial sector origins of inefficient economic booms

Author(s): Frédéric Malherbe and Michael McMahon

Publication Date: August 2020

Keyword(s):

Programme Area(s): Financial Economics and Monetary Economics and Fluctuations

Abstract: Government guarantees to banks are ubiquitous. We study an equilibrium model where, in the presence of such guarantees, the equilibrium allocation can be characterised as Panglossian: it corresponds to that of a deterministic economy where the best possible state always occurs. However, GDP is inefficiently high and expected consumption inefficiently low. Financial sophistication magnifies this distortion, taking the allocation beyond the Panglossian outcome (i.e. with even higher GDP and even lower expected consumption). We argue that this mechanism is empirically relevant for advanced economies and suggest that the Great Recession, partly, reversed a Great Distortion.

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Bibliographic Reference

Malherbe, F and McMahon, M. 2020. 'Beyond Pangloss: Financial sector origins of inefficient economic booms'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=15180