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Delayed crises and slow recoveries

Author

Listed:
  • Liu, Xuewen
  • Wang, Pengfei
  • Yang, Zhongchao

Abstract

We present a rational expectations model of credit-driven crises, providing a new perspective to explain why credit booms can lead to severe financial crises and aftermath slow economic recoveries. In our model economy, banks can operate in two types of business. They are sequentially aware of the deterioration of fundamentals of the speculative business and decide whether to continue credit extension in that business or liquidate capital and move into the traditional business. However, because individual banks face uncertainty about how many of their peers have been aware, they rationally choose to extend credit in the speculative business for a longer time than is socially optimal, leading to an over-delayed crisis and consequently more banks being caught by the crisis. This in turn renders the financial crisis more severe and the subsequent economic recovery slower. Extending to a standard textbook macroeconomic growth setting, our model also generates rich dynamics of economic booms, slowdowns, crashes, and recoveries.

Suggested Citation

  • Liu, Xuewen & Wang, Pengfei & Yang, Zhongchao, 2024. "Delayed crises and slow recoveries," Journal of Financial Economics, Elsevier, vol. 152(C).
  • Handle: RePEc:eee:jfinec:v:152:y:2024:i:c:s0304405x23001976
    DOI: 10.1016/j.jfineco.2023.103757
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    More about this item

    Keywords

    Credit extensions; Synchronization; Externality; Economic recoveries;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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