The paper by Emmanuel Farhi and Jean Tirole explores the dynamics of collective moral hazard, maturity mismatch, and systemic bailouts in financial crises. The authors argue that private leverage choices exhibit strategic complementarities due to the non-targeted nature of monetary policy. When many institutions engage in maturity transformation, authorities are forced to facilitate refinancing, which can lead to excessive leverage and systemic risk. The key insight is that the benefits of a monetary bailout accrue proportionally to the amount of leverage, while the distortion costs are largely fixed. This leads to several important consequences: 1. **Strategic Complementarities**: Banks choose to correlate their risk exposures, and private borrowers may increase their interest-rate sensitivity to manage liquidity risks. 2. **Optimal Monetary Policy**: It is time-inconsistent, as authorities must balance the need to support institutions with the distortion costs of low interest rates. 3. **Macroeconomic Uncertainty**: Banks choose to maximize the correlation of their shocks, contrary to conventional wisdom. 4. **Regulation**: A minimum liquidity requirement and monitoring of liquid asset quality are optimal, with regulation confined to key institutions. The paper also analyzes the optimal bailout mix, showing that monetary policy is always used in equilibrium, while fiscal bailouts are used in conjunction with monetary policy for strategic actors like commercial banks. The insights are robust when the set of bailout instruments is endogenous, and the optimal bailout policy is characterized. The authors conclude with a discussion of the implications for regulatory reform and the need for macro-prudential supervision.The paper by Emmanuel Farhi and Jean Tirole explores the dynamics of collective moral hazard, maturity mismatch, and systemic bailouts in financial crises. The authors argue that private leverage choices exhibit strategic complementarities due to the non-targeted nature of monetary policy. When many institutions engage in maturity transformation, authorities are forced to facilitate refinancing, which can lead to excessive leverage and systemic risk. The key insight is that the benefits of a monetary bailout accrue proportionally to the amount of leverage, while the distortion costs are largely fixed. This leads to several important consequences: 1. **Strategic Complementarities**: Banks choose to correlate their risk exposures, and private borrowers may increase their interest-rate sensitivity to manage liquidity risks. 2. **Optimal Monetary Policy**: It is time-inconsistent, as authorities must balance the need to support institutions with the distortion costs of low interest rates. 3. **Macroeconomic Uncertainty**: Banks choose to maximize the correlation of their shocks, contrary to conventional wisdom. 4. **Regulation**: A minimum liquidity requirement and monitoring of liquid asset quality are optimal, with regulation confined to key institutions. The paper also analyzes the optimal bailout mix, showing that monetary policy is always used in equilibrium, while fiscal bailouts are used in conjunction with monetary policy for strategic actors like commercial banks. The insights are robust when the set of bailout instruments is endogenous, and the optimal bailout policy is characterized. The authors conclude with a discussion of the implications for regulatory reform and the need for macro-prudential supervision.