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What causes banking crises? An empirical investigation

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  • Le, Vo Phuong Mai
  • Meenagh, David
  • Minford, Patrick

Abstract

We add the Bernanke-Gertler-Gilchrist model to a modified version of the Smets-Wouters model of the US in order to explore the causes of the banking crisis. We test the model against the data on HP-detrended data and reestimate it by indirect inference; the resulting model passes the Wald test on output, inflation and interest rates. We then extract the model's implied residuals on US unfiltered data since 1984 to replicate how the model predicts the crisis. The main banking shock tracks the unfolding `sub-prime' shock, which appears to have been authored mainly by US government intervention. This shock worsens the banking crisis but `traditional' shocks explain the bulk of the crisis; the non-stationarity of the productivity shock plays a key role. Crises occur when there is a `run' of bad shocks; based on this sample they occur on average once every 40 years and when they occur around half are accompanied by financial crisis. Financial shocks on their own, even when extreme, do not cause crises --- provided the government acts swiftly to counteract such a shock as happened in this sample.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9057.

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Date of creation: Jul 2012
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Handle: RePEc:cpr:ceprdp:9057

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Keywords: Banking; Bootstrap; Crisis; DSGE;

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  1. Le, Vo Phuong Mai & Minford, Patrick & Wickens, Michael, 2013. "A Monte Carlo procedure for checking identification in DSGE models," Cardiff Economics Working Papers E2013/4, Cardiff University, Cardiff Business School, Economics Section.
  2. Davidson, James & Meenagh, David & Minford, Patrick & Wickens, Michael, 2010. "Why crises happen - nonstationary macroeconomics," Cardiff Economics Working Papers E2010/13, Cardiff University, Cardiff Business School, Economics Section.
  3. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  4. L. Ingber, 2012. "Adaptive simulated annealing," Lester Ingber Papers 12as, Lester Ingber.
  5. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick & Wickens, Michael, 2012. "Testing DSGE models by Indirect inference and other methods: some Monte Carlo experiments," Cardiff Economics Working Papers E2012/15, Cardiff University, Cardiff Business School, Economics Section.
  6. Gourieroux, C. & Monfort, A. & Renault, E., 1992. "Indirect Inference," Papers 92.279, Toulouse - GREMAQ.
  7. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick & Wickens, Michael, 2008. "How much nominal rigidity is there in the US economy? Testing a New Keynesian DSGE Model using indirect inference," Cardiff Economics Working Papers E2008/32, Cardiff University, Cardiff Business School, Economics Section, revised Jul 2011.
  8. Allan W. Gregory & Gregor W. Smith, 1991. "Calibration in Macroeconomics," Working Papers 826, Queen's University, Department of Economics.
  9. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  10. Del Negro, Marco & Schorfheide, Frank & Smets, Frank & Wouters, Rafael, 2007. "On the Fit of New Keynesian Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 123-143, April.
  11. Stephan Fahr & Roberto Motto & Massimo Rostagno & Frank Smets & Oreste Tristani, 2013. "A monetary policy strategy in good and bad times: lessons from the recent past," Economic Policy, CEPR & CES & MSH, vol. 28(74), pages 243-288, 04.
  12. Miles S. Kimball, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," NBER Working Papers 5046, National Bureau of Economic Research, Inc.
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Cited by:
  1. Liu, Chunping & Minford, Patrick, 2012. "Comparing behavioural and rational expectations for the US post-war economy," CEPR Discussion Papers 9132, C.E.P.R. Discussion Papers.

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