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Article

Destructive Effects of Constructive Ambiguity in Risky Times

Journal of International Money and Finance. 2012. Vol. 31. No. 6. P. 1459-1481.

Unclear bailout policy, underinvestment and calls for greater responsibility by bankers are
some of the observations from the recent financial crisis. The paper explains
underinvestment as an inefficient equilibrium. Under ambiguous bailout policy agents suffer
from a lack of information about the insolvency resolution methods. The beliefs of bankers
regarding whether an insolvent bank is liquidated, may differ from those of depositors even if
bankers and depositors possess absolutely symmetric information about the economy. This
disrupts the flow of funds through the banking channel if the investment climate is
characterized by high aggregate risk. The paper suggests policy implications aimed at a
reduction of the anxiety of agents and at aligning their beliefs to restore efficiency.