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Banks, Liquidity Crises and Economic Growth

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  • Alejandro Gaytan
  • Romain Ranciere

Abstract

How do the liquidity functions of banks affect investment and growth at different stages of economic development? How do financial fragility and the costs of banking crises evolve with the level of wealth of countries? We analyze these issues using an overlapping generations growth model where agents, who experience idiosyncratic liquidity shocks, can invest in a liquid storage technology or in a partially illiquid Cobb Douglas technology. By pooling liquidity risk, banks play a growth enhancing role in reducing inefficient liquidation of long term projects, but they may face liquidity crises associated with severe output losses. We show that middle income economies may find optimal to be exposed to liquidity crises, while poor and rich economies have more incentives to develop a fully covered banking system. Therefore, middle income economies could experience banking crises in the process of their development and, as they get richer, they eventually converge to a financially safe long run steady state. Finally, the model replicates the empirical fact of higher costs of banking crises for middle income economies

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 399.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:399

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Keywords: OLG growth models; liquidity; financial intermediation; financial fragility; banking crises;

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Citations

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Cited by:
  1. Romain Ranciere & Aaron Tornell & Frank Westermann, 2004. "Crises and Growth: A Re-evaluation," UCLA Economics Working Papers 832, UCLA Department of Economics.
  2. Norman Loayza & Romain Ranciere, 2002. "Financial Development, Financial Fragility, and Growth," Working Papers Central Bank of Chile 145, Central Bank of Chile.
  3. Alejandro Gaytan & Romain Rancière, 2004. "Wealth, financial intermediation and growth," Economics Working Papers 851, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2004.
  4. Hnatkovska, Viktoria & Loayza, Norman, 2004. "Volatility and growth," Policy Research Working Paper Series 3184, The World Bank.
  5. Huberto M. Ennis & Todd Keister, 2004. "Bank runs and investment decisions revisited," Working Paper 04-03, Federal Reserve Bank of Richmond.
  6. Edoardo Gaffeo & Petya Garalova, 2014. "On the finance-growth nexus: additional evidence from Central and Eastern Europe countries," Economic Change and Restructuring, Springer, vol. 47(2), pages 89-115, May.
  7. Wu, Jyh-Lin & Hou, Han & Cheng, Su-Yin, 2010. "The dynamic impacts of financial institutions on economic growth: Evidence from the European Union," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 879-891, September.
  8. Su-Yin Cheng & Chia-Cheng Ho & Han Hou, 2014. "The Finance-growth Relationship and the Level of Country Development," Journal of Financial Services Research, Springer, vol. 45(1), pages 117-140, February.
  9. Miller, Victoria, 2008. "Bank runs, foreign exchange reserves and credibility: When size does not matter," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(5), pages 557-565, December.
  10. Aaron Tornell, 2003. "Crises and Growth: A Re-evaluation (September 2003)," UCLA Economics Online Papers 264, UCLA Department of Economics.

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