This paper identifies two types of market failures. The first concerns a coordination problem associated with panics. The problem in analysing this type of market failure from a policy perspective is that there is no widely accepted method for selecting equilibria. The second market failure concerns the incompleteness of financial markets. The essential problem here is that the incentives to provide liquidity lead to an inefficient allocation of resources. The paper outlines three manifestations of market failure associated with liquidity provision: financial fragility, contagion and asset price bubbles. The framework developed allows some insight into the question of when the financial system acts a shock absorber and when it acts as an amplifier. Having identified when there is a market failure, the paper looks at whether there are policies that can correct the undesirable effects of such failures.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Bank for International Settlements in its series BIS Working Papers with number
257.