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Liquidity Flows and Fragility of Business Enterprises

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Author Info
Wouter J. den Haan
Garey Ramey
Joel Watson

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Abstract

This paper considers the efficiency of financial intermediation and the propagation of business cycle shocks in a model of long-term relationships between entrepreneurs and lenders, where lenders may be constrained in their short-run access to liquidity. When liquidity is low, relationships are subject to breakups that lead to loss of joint surplus. Liquidity outflows cause damage to financial structure by breaking up relationships, and damage persists due to frictions in the formation of new relationships. Feedbacks between aggregate investment and the structure of intermediation greatly magnify the effects of shocks. For large shocks, financial collapse may become inescapable in the absence of external intervention.

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Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number 99-07.

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Date of creation: Mar 1999
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Handle: RePEc:cdl:ucsdec:99-07

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