By Michael Chui, Prasanna Gai and Andy Haldane of the Bank’s International Finance Division.
This article describes a model of financial crisis and explores its implications for public policy. The framework nests the key features of earlier models but is better able to address international architecture questions in a welfare setting. In particular, this framework is used to assess the welfare costs of creditor coordination failure and several recent public policy proposals on reforming the international financial architecture. The costs of creditor coordination failures are found to be high. But policies that improve sovereign liquidity management or that stall creditor runs—such as payments standstills—can mitigate these costs.