Bailouts by Popular Demand
We characterize conditions under which the majority of voters supports a bailout despite incurring bailout expenditures. This yields inefficiently high investments when economic prospects are good. When economic prospects are poor, a policy that generates strictly positive bailout expenditures arises only if it is accompanied by a sufficiently high tax on bailout beneficiaries, thus yielding inefficiently low investments. Politicians’ bias against the majority can alleviate the procyclicality of the voters-driven allocative inefficiency, though full correction is not always possible. When households vote domestically but can invest across borders, allocative efficiency occurs but it is prone to politicians’ bias.
Co-Author(s): Nicholas Ziros