DOCSLIB.ORG

Econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Totzek, Alexander Working Paper The Bank, the Bank-Run, and the Central Bank: The Impact of Early Deposit Withdrawals in a New Keynesian Framework Economics Working Paper, No. 2008-20 Provided in Cooperation with: Christian-Albrechts-University of Kiel, Department of Economics Suggested Citation: Totzek, Alexander (2008) : The Bank, the Bank-Run, and the Central Bank: The Impact of Early Deposit Withdrawals in a New Keynesian Framework, Economics Working Paper, No. 2008-20, Kiel University, Department of Economics, Kiel This Version is available at: http://hdl.handle.net/10419/27675 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu The Bank, the Bank-Run, and the Central Bank: The Impact of Early Deposit Withdrawals in a New Keynesian Framework by Alexander Totzek Economics Working Paper No 200 8-20 The Bank, the Bank-Run, and the Central Bank: The Impact of Early Deposit Withdrawals in a New Keynesian Framework∗ Alexander Totzek∗∗ Department of Economics, Christian-Albrechts-University of Kiel, Olshausenstr. 40, D-24098 Kiel, Germany December 15, 2008 Abstract Currently, private trust in commercial banks declines as a consequence of today´s financial crisis. As past crises, e.g. the Asian crisis, show, the loss of confidence in the financial sector typically causes private agents to withdraw their capital from financial institutions. Thus, the purpose of this paper is to implement the feature of early deposit withdrawal in a New Keynesian framework with commercial banks in order to analyze the implications of a loss of confidence. In addition, we present the optimal monetary policy to ensure a stabilized system. JEL classification: E44, E50, G01 Keywords: banks, financial crises, deposit withdrawal, optimal monetary policy ∗ I would like to thank Hans-Werner Wohltmann, Roland Winkler, Stephen Sacht and Christian Merkl for very helpful comments. ∗∗ Phone: +49-431-880-1447, Fax: +49-431-880-2228, E-mail: [email protected] 1 Introduction Currently, private trust in commercial banks declines as a consequence of to- day´s financial crisis. As past crises, e.g. the Asian crisis, show, the loss of confidence in the financial sector typically causes private agents to withdraw their capital from financial institutions. The corresponding extreme case sce- nario would be the bank-run. Fortunately, this scenario has not yet occurred in today’s financial turmoil. But what happens, if it does? Therefore, the purpose of this paper is to develop a New Keynesian model with explicit consideration of early deposit withdrawals in order to analyze the implications of households’ loss of confidence in the financial system. Moreover, we will present the optimal monetary policy to ensure a stabilized system. The main results are: (i) the extended withdrawal leads to temporary stagflation. (ii) also an impulse shock leads to persistent real effects. (iii) the resulting welfare losses decrease in bank’s adjustment costs. (iv) the opti- mal central bank’s response is to rise the interest rate in order to increase the private costs of withdrawals. (v) the optimal monetary policy response implies that the impact recession is amplified while inflation is stabilized. This paper is related to recent literature as an implementation of early deposit withdrawal in a New Keynesian framework. Hence, like Henzel et al. (2007) or H¨ulsewig, Mayer and Wollmersh¨auser (2006), we explicitly model a third type of economic agent besides households and firms, namely the bank as a kind of profit maximizing firm. But in contrast to the latter studies that just implement commercial banks for the purpose of generating a cost channel, we allow the household to early withdraw deposits during the current period. However, there are several studies which investigate the impact of early deposit withdrawal on the financial system [e.g. Gilkeson et al. (1999), Ring- bom et al. (2004) or Stanhouse and Stock (2004)]. Other studies use such a framework for modelling financial problems [e.g. Carletti et al. (2007) who investigate the impact of bank mergers on liquidity needs or Diamond and Dy- bvig (1983) who investigate optimal bank contracts that can prevent bank-runs] but to our best knowledge, it has never been implemented in a New Keynesian framework, yet. Moreover, the analysis shows that the shock of confidence causes both the marginal costs of firms and banks to increase. Hence, the current paper can also be seen as a new approach for implementing a microfounded cost push shock in a New Keynesian framework. The remainder is structured as follows. Section 2 presents the basic idea of the interaction between the agents and the problems resulting from withdrawals. In section 3 the microfounded New Keynesian model for a closed economy with explicit consideration of the banking sector and the possibility for households of withdrawing deposits in a cash-in-advance framework is developed. The purpose of section 4 is to analyze the impulse responses to a shock in the withdrawal rate and the optimal monetary policy. In the last chapter, the main results are summarized. 1 2 Idea Apart from consumption demand and labor supply decisions, the household can invest money in form of interest-bearing deposits with a duration of one period at a loan bank. Within the period, the household can decide to break the contract with the bank and to early withdraw deposits. In the case that the household holds its deposits D till the end of the period, D it obtains a next period return of Rt Dt. But the household only fulfills the con- tract with the probability 1 − δt. With the counter probability δt the household withdraws its capital from the bank within the period. In this case deposits are converted into liquid money. In punishment of breaking the contract the household does not get any interest payments. Its payoff is then simply given by D. Hence, it is implicitly assumed that deposits contain an embedded with- drawal option. In contrast to the withdrawal per se, the option is assumed to be costless [see e.g. Gilkeson et al. (2000) or Stanhouse and Ingram (2007)]. Due to the temporal sequence of cash flows, firms have to pre-finance house- holds’ wages at the loan bank by credits. Banks’ business is therefore assumed to be given by pre-financing firms’ working capital with the usage of private deposits. Thereby, the amount of credits is limited by the amount of private deposits and banks’ reserve holdings. Reserves ℜt(i) are held to ensure the bank against liquidity shortages as a consequence of withdrawals. If the demand for liquidity δtDt(i) exceeds the reserve holdings, the loan I bank has to refinance the resulting liquidity gap at a final creditor with rt > L I L rt > rt, where rt , rt and rt denote the refinancing interest rate, the loan rate and the nominal interest rate (representing the central bank’s instrument variable), respectively. The final creditor or lender of last resort substitutes the interbank market for short-run capital since in turbulent times/financial crises, interbank markets often fail [see e.g. Freixas et al. (2000) or Kahn and Santos (2005)]. Moreover, it is assumed that liquidity needs will not force the single banks into bankruptcy and that hence the lender of last resort must possess unlimited liquidity. Figure 1 depicts the resulting cash flows between the differentiated types of agents. The interactions between banks and final creditor are put in parenthe- sis since they only occur if the amount of deposit withdrawals exceeds banks’ reserve holdings. For sake of simplicity, dividend payments from banks and firms are neglected in figure 1. Without any shock in confidence, the bank’s balance of payments is shown in table 1. In period t = 0 the households makes its deposits Dt(i) at bank i. t = 0 0 <t< 1 t = 1 D Dt(i) −δtDt(i) −(1 − δt)Rt Dt(i) L −Lt(i) ℜt(i)= δtDt(i) Rt Lt(i) −ℜ(i)= δtDt(i) 0 0 > 0 Table 1: The Bank’s balance of payments without confidence shock 2 Creditor 6 (credits) ? (interest payments) withdrawal @I Banks @ interest@ paymentsdeposits @ @ @ @ credits @ @ @ @ @ © @@R @ ? interest paymentsgoods expenditure Firms - Households labor income Figure 1: cash flows The contributed capital the bank deals in credits Lt(i) for firms and in reserves ℜt(i). The bank chooses the amount of reserves as ℜt(i) = δtDt(i) to ensure itself against the expected withdrawal during the period. In 0 <t< 1 some constant fraction of households δt = δ now withdraws its capital. Since the bank has considered that in its reserve holding decision, the balance of payments is even within the period. At the beginning of t = 1 (or at the end of t = 0) the fraction 1 − δt of households that has not withdrawn its deposits gets its D interest payments Rt Dt(i).
Load more

Recommended publications
  • Uncertainty and Hyperinflation: European Inflation Dynamics After World War I
    FEDERAL RESERVE BANK OF SAN FRANCISCO WORKING PAPER SERIES Uncertainty and Hyperinflation: European Inflation Dynamics after World War I Jose A. Lopez Federal Reserve Bank of San Francisco Kris James Mitchener Santa Clara University CAGE, CEPR, CES-ifo & NBER June 2018 Working Paper 2018-06 https://www.frbsf.org/economic-research/publications/working-papers/2018/06/ Suggested citation: Lopez, Jose A., Kris James Mitchener. 2018. “Uncertainty and Hyperinflation: European Inflation Dynamics after World War I,” Federal Reserve Bank of San Francisco Working Paper 2018-06. https://doi.org/10.24148/wp2018-06 The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System. Uncertainty and Hyperinflation: European Inflation Dynamics after World War I Jose A. Lopez Federal Reserve Bank of San Francisco Kris James Mitchener Santa Clara University CAGE, CEPR, CES-ifo & NBER* May 9, 2018 ABSTRACT. Fiscal deficits, elevated debt-to-GDP ratios, and high inflation rates suggest hyperinflation could have potentially emerged in many European countries after World War I. We demonstrate that economic policy uncertainty was instrumental in pushing a subset of European countries into hyperinflation shortly after the end of the war. Germany, Austria, Poland, and Hungary (GAPH) suffered from frequent uncertainty shocks – and correspondingly high levels of uncertainty – caused by protracted political negotiations over reparations payments, the apportionment of the Austro-Hungarian debt, and border disputes. In contrast, other European countries exhibited lower levels of measured uncertainty between 1919 and 1925, allowing them more capacity with which to implement credible commitments to their fiscal and monetary policies.
    [Show full text]
  • 12. the Recent Crisis – and Recovery – of the Argentine Economy: Some Elements and Background
    12. The Recent Crisis – and Recovery – of the Argentine Economy: Some Elements and Background Arturo O’Connell ______________________________________________________________ INTRODUCTION The Argentine crisis could be examined as one more crisis of the developing countries – admittedly a star pupil that had received praise from many sides – hit by the vagaries of the international financial markets and/or its own policy mistakes. To a great extent that is a line of argument that could provide some illumination. However, it could be even more interesting to examine the peculiarities of the Argentine experience – always in that general context –that have made it such an intractable case for normal medication. Not only would it be best to pin down those peculiarities and their consequences, but also it is necessary to understand that they were not just a result of the eccentricities of some people in some far-off Southern end of the world. Finance, both external and domestic, is one essential part of the story. Argentina became one of the most highly liberalized financial systems in the world. Capital could freely flow in and out without even clear registration demands; big firms profited from such a system by being able to finance themselves – at cheaper financial costs – in the international market at the same time that wealthy families chose to hold a significant proportion of their liquid assets abroad. The domestic banking system was opened to foreign entry to the point of not requiring the habitual reciprocity with third countries and a large and increasing proportion of the operations became denominated in foreign currency. To build up confidence in the local currency a hard peg to the US dollar was instituted by law rather than by Executive Order and the Central Bank became a mere currency board issuing currency at the legally determined rate only against foreign exchange.
    [Show full text]
  • JP Morgan and the Money Trust
    FEDERAL RESERVE BANK OF ST. LOUIS ECONOMIC EDUCATION The Panic of 1907: J.P. Morgan and the Money Trust Lesson Author Mary Fuchs Standards and Benchmarks (see page 47) Lesson Description The Panic of 1907 was a financial crisis set off by a series of bad banking decisions and a frenzy of withdrawals caused by public distrust of the banking system. J.P. Morgan, along with other wealthy Wall Street bankers, loaned their own funds to save the coun- try from a severe financial crisis. But what happens when a single man, or small group of men, have the power to control the finances of a country? In this lesson, students will learn about the Panic of 1907 and the measures Morgan used to finance and save the major banks and trust companies. Students will also practice close reading to analyze texts from the Pujo hearings, newspapers, and reactionary articles to develop an evidence- based argument about whether or not a money trust—a Morgan-led cartel—existed. Grade Level 10-12 Concepts Bank run Bank panic Cartel Central bank Liquidity Money trust Monopoly Sherman Antitrust Act Trust ©2015, Federal Reserve Bank of St. Louis. Permission is granted to reprint or photocopy this lesson in its entirety for educational purposes, provided the user credits the Federal Reserve Bank of St. Louis, www.stlouisfed.org/education. 1 Lesson Plan The Panic of 1907: J.P. Morgan and the Money Trust Time Required 100-120 minutes Compelling Question What did J.P. Morgan have to do with the founding of the Federal Reserve? Objectives Students will • define bank run, bank panic, monopoly, central bank, cartel, and liquidity; • explain the Panic of 1907 and the events leading up to the panic; • analyze the Sherman Antitrust Act; • explain how monopolies worked in the early 20th-century banking industry; • develop an evidence-based argument about whether or not a money trust—a Morgan-led cartel—existed • explain how J.P.
    [Show full text]
  • Global European Banks and the Financial Crisis
    Global European Banks and the Financial Crisis Bryan Noeth and Rajdeep Sengupta This paper reviews some of the recent studies on international capital flows with a focus on the role of European global banks. It presents a revision to the commonly held “global saving glut” view that East Asian economies (along with oil-rich nations) were the dominant suppliers of capital that fueled the asset price boom in many parts of the world in the early 2000s. It argues that the role of funding costs and a “liberal” regulatory regime that allowed for an unprecedented expansion of the balance sheets of European banks was no less important. Finally, we describe the aftermath of the crisis in terms of some of the challenges faced by Europe as a whole and European banks in particular. (JEL F32, G15, G21, E44) Federal Reserve Bank of St. Louis Review , November/December 2012, 94 (6), pp. 457-79. significant economic slowdown currently plagues the world economy, especially the countries in Europe. This slowdown comes in the aftermath of what has been widely A regarded as an ongoing global financial turmoil that has spanned the past half decade (2007-12). The economic woes are especially severe in the euro zone, where countries battle not only an economic recession, but also asset price deflation and a burgeoning debt crisis. 1 Given the enormity of the economic crisis in the euro zone and the length and breadth of its impact, different studies have emphasized different aspects of the crisis. This paper presents a brief overview of the role played by global finance in the crisis in the euro zone.
    [Show full text]
  • Friday, June 21, 2013 the Failures That Ignited America's Financial
    Friday, June 21, 2013 The Failures that Ignited America’s Financial Panics: A Clinical Survey Hugh Rockoff Department of Economics Rutgers University, 75 Hamilton Street New Brunswick NJ 08901 [email protected] Preliminary. Please do not cite without permission. 1 Abstract This paper surveys the key failures that ignited the major peacetime financial panics in the United States, beginning with the Panic of 1819 and ending with the Panic of 2008. In a few cases panics were triggered by the failure of a single firm, but typically panics resulted from a cluster of failures. In every case “shadow banks” were the source of the panic or a prominent member of the cluster. The firms that failed had excellent reputations prior to their failure. But they had made long-term investments concentrated in one sector of the economy, and financed those investments with short-term liabilities. Real estate, canals and railroads (real estate at one remove), mining, and cotton were the major problems. The panic of 2008, at least in these ways, was a repetition of earlier panics in the United States. 2 “Such accidental events are of the most various nature: a bad harvest, an apprehension of foreign invasion, the sudden failure of a great firm which everybody trusted, and many other similar events, have all caused a sudden demand for cash” (Walter Bagehot 1924 [1873], 118). 1. The Role of Famous Failures1 The failure of a famous financial firm features prominently in the narrative histories of most U.S. financial panics.2 In this respect the most recent panic is typical: Lehman brothers failed on September 15, 2008: and … all hell broke loose.
    [Show full text]
  • Financial Catastrophe Research & Stress Test Scenarios
    Cambridge Judge Business School Centre for Risk Studies 7th Risk Summit Research Showcase Financial Catastrophe Research & Stress Test Scenarios Dr Andy Skelton Research Associate, Cambridge Centre for Risk Studies 20 June 2016 Cambridge, UK Financial Catastrophe Research 1. Catalogue of historical financial events 2. Development of stress test scenarios 3. Understanding contagion processes in financial networks (eg, interbank loans) - Network models & visualisations - Role of central banks in financial crises - Practitioner model – scoping exercise 2 Learning from History Financial systems and transaction technologies have changed But principles of credit cycles, human trust and financial interrelationships that trigger crises remain relevant 12 Historical Financial Crisis Crises occur periodically – Different causes and severities – Every 8 years on average – $0.5 Tn of lost annual economic output – 1% of global economic output Without FinCat global growth could be 4% a year instead of 3% Financial catastrophes are the single greatest economic risk for society – We need to understand them better 3 Historical Severities of Crashes – Past 200 Years US Stock Market Crashes UK Stock Market Crashes 1845 Railway Mania… 1845 Railway Mania… 1997 Asian Crisis 1997 Asian Crisis 1866 Collapse of Overend… 1866 Collapse of Overend… 1825 Latin American Crisis 1825 Latin American Crisis 1983 Latin American Debt… 1983 Latin American Debt… 1837 Cotton Crisis 1837 Cotton Crisis 1857 Railroad Mania… 1857 Railroad Mania… 1907 Knickerbocker 1907 Knickerbocker
    [Show full text]
  • The Many Panics of 1837 People, Politics, and the Creation of a Transatlantic Financial Crisis
    The Many Panics of 1837 People, Politics, and the Creation of a Transatlantic Financial Crisis In the spring of 1837, people panicked as financial and economic uncer- tainty spread within and between New York, New Orleans, and London. Although the period of panic would dramatically influence political, cultural, and social history, those who panicked sought to erase from history their experiences of one of America’s worst early financial crises. The Many Panics of 1837 reconstructs the period between March and May 1837 in order to make arguments about the national boundaries of history, the role of information in the economy, the personal and local nature of national and international events, the origins and dissemination of economic ideas, and most importantly, what actually happened in 1837. This riveting transatlantic cultural history, based on archival research on two continents, reveals how people transformed their experiences of financial crisis into the “Panic of 1837,” a single event that would serve as a turning point in American history and an early inspiration for business cycle theory. Jessica M. Lepler is an assistant professor of history at the University of New Hampshire. The Society of American Historians awarded her Brandeis University doctoral dissertation, “1837: Anatomy of a Panic,” the 2008 Allan Nevins Prize. She has been the recipient of a Hench Post-Dissertation Fellowship from the American Antiquarian Society, a Dissertation Fellowship from the Library Company of Philadelphia’s Program in Early American Economy and Society, a John E. Rovensky Dissertation Fellowship in Business History, and a Jacob K. Javits Fellowship from the U.S.
    [Show full text]
  • Bank Runs and Private Remedies
    43 Gerald P. Dwyer, Jr. and R. Alton Gilbert Gerald P. Dwyer, Jr., a professor of economics at Clemson University, is a visiting scholar and R. Alton Gilbert is an assistant vice president at the Federal Reserve Bank of St. Louis. Erik A. Hess and Kevin L. Kliesen provided research assistance. Bank Runs and Private Remedies URRENT banking regulation in the United lessened their impact. These private remedies States is based in part on the notion that both did not solve the problem of runs, but they did the banking system and the economy must be mitigate the effects of the runs on the banks protected from the adverse effects of bank and the economy. In this article, we explain the runs. An example often cited as typical is the private remedies for runs and provide some string of bank runs from 1930 to 1933, which evidence on the frequency and severity of runs conventional wisdom holds responsible for on the banking system. thousands of bank failures and the Banking Holiday of 1933 when all banks closed. The BANK RUN’S: THE THEORY runs on savings associations in Ohio and Mary- land in 1985 are more recent examples. Before examining the history of bank runs, it This conventional view is reflected in a recent is useful to consider why banks at-c vulnerable comment on the “Panic of 1907” in the Wall to runs. This examination establishes a frame- Street Journal (1989): work for determining the kinds of observations that would be consistent with their occurrence. Long lines of depositors outside the closed doors of their banks signaled yet another financial crisis, Runs on Individual Banks an all-too familiar event around the turn of the century.
    [Show full text]
  • Recurring Storms: Weathering the Future by Understanding the Past
    The Global Business Law Review Volume 1 Issue 1 Article 4 2010 Recurring Storms: Weathering the Future by Understanding the Past Robert L. Brown Ph.D. Greenebaum, Doll & McDonald Follow this and additional works at: https://engagedscholarship.csuohio.edu/gblr Part of the Banking and Finance Law Commons, and the International Trade Law Commons How does access to this work benefit ou?y Let us know! Recommended Citation Robert L. Brown Ph.D., Recurring Storms: Weathering the Future by Understanding the Past , 1 Global Bus. L. Rev. 1 (2010) available at https://engagedscholarship.csuohio.edu/gblr/vol1/iss1/4 This Article is brought to you for free and open access by the Journals at EngagedScholarship@CSU. It has been accepted for inclusion in The Global Business Law Review by an authorized editor of EngagedScholarship@CSU. For more information, please contact [email protected]. RECURRING STORMS: WEATHERING THE FUTURE BY UNDERSTANDING THE PAST ROBERT L. BROWN I. TULIPMANIA 1637 ................................................................... 2 A. Boom................................................................................ 2 B. Bust .................................................................................. 3 C. Aftermath ......................................................................... 3 D. Summary .......................................................................... 4 II. MISSISSIPPI SCHEME 1720 ....................................................... 4 A. Boom...............................................................................
    [Show full text]
  • Human Behavior and the Panic of 1907
    12/19/2017 Human Behavior And The Panic Of 1907 News Categories About Us VALUE INVESTING Tools Timeless Reading Books Letters Search … Human Behavior And The Panic Of 1907 By John Huber • on December 18, 2017 6:00 pm • in Value Investing I recently wrote a post about a book I really liked called America’s Bank, by Roger Lowenstein. The book talks about the formation of the Federal Reserve, and the events that led to it. One of the major catalysts that started the process of banking reform was the Panic of 1907. On a related note, Seth Klarman’s favorite books include everything by Roger Lowenstein Get The Timeless RECENT POSTS Reading eBook in PDF / MORE NEWS Get the entire 10-part series on Timeless Reading in PDF. Save it to your desktop, read it on your tablet, or email to your How Articial Intelligence Is colleagues. Charting The Future For Mobile http://www.valuewalk.com/2017/12/human-behavior-panic-1907/ 1/9 12/19/2017 Human Behavior And The Panic Of 1907 email address Payments GET THE PDF Why AI Could Be Entering A Golden Age Richard Thaler: “I Have More Faith In Mankind Than Economists Do” Think This Is The Longest Bull Market Ever? Not Yet Ecient Markets …. Right Move Over AI And Machine Learning, Quantum Computing Is The Real Game Changer Mohnish Pabrai On Philanthropy And Investing Chemical Activity Accelerating…if it holds, we aren’t even close to the end of the rising market schlappohr / Pixabay What Caused the Panic of 1907? http://www.valuewalk.com/2017/12/human-behavior-panic-1907/ 2/9 12/19/2017 Human Behavior And The Panic Of 1907 Basically, the Panic of 1907 was caused by a classic run on the bank, leading to the failure of the Knickerbocker Trust company in New York, which drained cash reserves from the nancial system and created a shortage of liquidity all over the city and eventually in the broader economy.
    [Show full text]
  • Preventing Bank Runs
    Economic Brief March 2018, EB18-03 Preventing Bank Runs By Renee Haltom and Bruno Sultanum Banking can be defined as the business of maturity transformation, or “borrowing short to lend long.” Economists and policymakers have long viewed banking as inherently unstable, that is, prone to runs. This Economic Brief reviews the intuition and theory behind bank runs and the most popular proposed solutions. It also explores new research suggesting that runs might be prevented by creating a new, low-cost type of deposit contract that eliminates the incentive to run. Banking can be defined as the business of matu- crisis as having resembled a traditional bank run rity transformation, or “borrowing short to lend across many markets.1 Given the potential costs long.” For example, commercial banks take de- of runs, preventing them is of interest to policy- posits from households and businesses — short- makers and the general public. term liabilities that depositors can withdraw on demand — and use them to make longer-term This Economic Brief reviews the basic theory of loans to other households and businesses. runs and describes how the economics profes- Banking activity does not take place only within sion has explored potential solutions. It also pres- commercial banks; entities ranging from money ents a new solution proposed in a recent model market mutual funds to investment banks per- by one author of this brief (Sultanum) along with form this bank-like function in what has become David Andolfatto of the St. Louis Fed and Ed known as the “shadow-banking” sector. Nosal of the Atlanta Fed.
    [Show full text]
  • Global Financial Crisis: a Minskyan Interpretation of the Causes, the Fed’S Bailout, and the Future
    Working Paper No. 711 Global Financial Crisis: A Minskyan Interpretation of the Causes, the Fed’s Bailout, and the Future by L. Randall Wray Levy Economics Institute of Bard College March 2012 *This paper reports research undertaken as part of a Ford Foundation project, “A Research And Policy Dialogue Project On Improving Governance Of The Government Safety Net In Financial Crisis.” The author thanks June Carbone for comments and Andy Felkerson and Nicola Matthews for assistance. The Levy Economics Institute Working Paper Collection presents research in progress by Levy Institute scholars and conference participants. The purpose of the series is to disseminate ideas to and elicit comments from academics and professionals. Levy Economics Institute of Bard College, founded in 1986, is a nonprofit, nonpartisan, independently funded research organization devoted to public service. Through scholarship and economic research it generates viable, effective public policy responses to important economic problems that profoundly affect the quality of life in the United States and abroad. Levy Economics Institute P.O. Box 5000 Annandale-on-Hudson, NY 12504-5000 http://www.levyinstitute.org Copyright © Levy Economics Institute 2012 All rights reserved ISSN 1547-366X ABSTRACT This paper provides a quick review of the causes of the Global Financial Crisis that began in 2007. There were many contributing factors, but among the most important were rising inequality and stagnant incomes for most American workers, growing private sector debt in the United States and many other countries, financialization of the global economy (itself a very complex process), deregulation and desupervision of financial institutions, and overly tight fiscal policy in many nations.
    [Show full text]