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.
Analytical models can be useful in assessing public policy means of preventing and resolving crisis.
They allow quantified, welfare-based policy analysis. This article has outlined one particular model of crisis and used it to explore the welfare costs of crisis and the implications of certain policy measures to resolve crisis. Future research might usefully consider relaxing some of the more restrictive assumptions in the model. First, we assume that the quantum of debt and the form of the debt contract is fixed in advance. Debt size and debt structure might be affected importantly by some of the public policy measures considered here.