Financial Stability with Sovereign Debt

Are government guarantees or fnancial regulation a more effective way to prevent banking crises? I study this question in the presence of a negative feedback loop between the fscal position of the government and the health of the banking sector. I construct a model of fnancial intermediation in which the government issues, and may default on, debt. Banks hold some of this debt, which ties their health to that of the government. The government's tax revenue, in turn, depends on the quantity of investment that banks are able to fnance. I compare the effectiveness of government guarantees, liquidity regulation, and a combination of these policies in preventing self-fulflling bank runs. In some cases, a combination of the two policies is needed to prevent a run. In other cases, liquidity regulation alone is effective and adding guarantees would make the fnancial system fragile.