A Model to Analyse Financial Fragility
AbstractOur purpose in this paper is to produce a tractable model which illuminates problems relating to individual bank behaviour and risk-taking, to possible contagious inter-relationships between banks, and to the appropriate design of prudential requirements and incentives to limit `excessive` risk-taking. Our model is rich enough to include heterogenous agents (commercial banks and investors), endogenous default, and multiple commodity, and credit and deposit markets. Yet, it is simple enough to be effectively computable. Financial fragility emerges naturally as an equilibrium phenomenon. In our model a version of the liquidity trap can occur. Moreover, the Modigliani-Miller proposition fails either through frictions in the (nominal) financial system or through incentives, arising from the imposed capital requirements, for differential investment behaviour because of capital requirements. In addition, a non-trivial quantity theory of money is derived, liquidity and default premia co-determine interest rates, and both regulatory and monetary policies have non-neutral effects. The model also indicates how monetary policy may affect financial fragility, thus highlighting the trade-off between financial stability.
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Bibliographic InfoPaper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 2003-FE-13.
Date of creation: 01 Oct 2003
Date of revision:
Other versions of this item:
- Charles Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A model to analyse financial fragility," LSE Research Online Documents on Economics 24703, London School of Economics and Political Science, LSE Library.
- Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2003. "A Model to Analyse Financial Fragility," OFRC Working Papers Series 2003fe13, Oxford Financial Research Centre.
- F3 - International Economics - - International Finance
- G3 - Financial Economics - - Corporate Finance and Governance
- J1 - Labor and Demographic Economics - - Demographic Economics
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