Bank Bailouts and Redistributive Monetary Policy: Voting on Central Bank Independence

Abstract

In this paper bank bailout rules and central bank independence (CBI) are determined by majority voting. The failure of a bank is socially costly, since bailouts are financed by distortionary taxation. The tax distortion can be reduced via monetization, i.e. lowering CBI; but monetization causes in‡flation. There is a socially optimal level of bailout and CBI, which solves the trade-off between monetary stability and banking stability. This level, however, is rarely adopted. Since individuals have heterogeneous portfolios, the bailout and the central bank'’s policy have redistributive consequences. Thus the preferences for monetary stability and banking stability are different across individuals. The actual level of CBI that a society will choose is determined by how public debt and bank ownership are distributed in individuals’' portfolios.