Distributional Effects of Crises: The Financial Channel

Who pays for financial crises? What are the mechanisms for spreading the cost across different social groups? The literature is only beginning to provide answers to these crucial questions. Several papers measure the depth and duration of crises, defined as the cumulative output loss and recovery time, and conclude that these crises have been very costly for developed and emerging economies. However, in this paper we argue that the recent literature overlooks an important channel: the financial channel. We focus on financial crises that involve bailouts and ask who pays for bailouts and how bailouts affect income distribution. We first analyze transfers from nonparticipants to participants in the financial sector, including creditors, debtors, and financial institutions. Then we ask who receives these financial transfers within the financial sector and what other redistributions take place among financial sector participants. For this we consider the behavior of different participants—namely, small and large depositors, domestic and foreign investors, small and large borrowers, and related and nonrelated companies.