Resolving Systemic Crises: Policies and Institutions

We analyze the role of policy and institutions in resolving a systemic crisis for a broad sample of countries. As others have documented before, we find that extensive liquidity support, (unlimited) government guarantees on financial institutions’ liabilities and forbearance from prudential regulations add to the fiscal costs of resolution. Although these accommodative policies are costly, they do not accelerate the recovery from a crisis. Better institutions—lower corruption, greater law and order, better legal system, and a better bureaucracy—do, however, lower costs and accelerate economic recovery. We find these results using both country and industry level data and to be relatively robust to estimation techniques and samples. They suggest that countries best use strict policies to resolve a crisis and focus on structural reforms, which, as has been shown elsewhere, will also help avoid future systemic crises.

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