Banking panics and output dynamics

This paper develops a dynamic general equilibrium model with an essential role for an illiquid banking system to investigate output dynamics in the event of a banking crisis. In particular, it considers the ex-post efficient policy response to a banking crisis as part of the dynamic equilibrium anal...

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Bibliographic Details
Published in:Review of economic dynamics 2018-07, Vol.29, p.148-171
Main Author: Sanches, Daniel
Format: Article
Language:English
Subjects:
Banking panic
Deposit contract
Suspension of convertibility
Time-consistent policies
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Summary:This paper develops a dynamic general equilibrium model with an essential role for an illiquid banking system to investigate output dynamics in the event of a banking crisis. In particular, it considers the ex-post efficient policy response to a banking crisis as part of the dynamic equilibrium analysis. It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of the liquidation cost, the recession associated with a banking panic is protracted as a result of the premature liquidation of a large fraction of productive banking assets to respond to a panic. For intermediate values, the recession is more severe but short-lived. For relatively large values, the contemporaneous decline in real output in the event of a panic is substantial but followed by a vigorous rebound in real activity above the long-run level.
ISSN:1094-2025
1096-6099
DOI:10.1016/j.red.2017.12.009