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Banking Policy without Commitment: Suspension of Convertibility Taken Seriously

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  • Huberto M. Ennis

    ()
    (Research Department Federal Reserve Bank of Richmond)

  • Todd Keister

Abstract

We study banking policy credibility in a variant of the Diamond and Dybvig (JPE, 1983) model. By committing to temporarily close banks during a run, suspending the convertibility of deposits into currency, the banking authority can eliminate the possibility of a bank run as an equilibrium outcome. Without commitment, however, if a run were to actually occur it may not be optimal for the authority to keep its promise to suspend convertibility. In other words, the threat of suspension may not be credible. We derive conditions under which a credible suspension scheme can be used to rule out bank runs and conditions under which it cannot. In the latter case, bank runs can occur even when there is no uncertainty about aggregate liquidity demand. We relate the analysis to events in Argentina in 2001, when a system-wide suspension of convertibility was declared but only partially enforced

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 464.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:464

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Keywords: Optimal Policy; Credibility; Time Consistency; Bank Runs;

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  1. Chari, V V & Kehoe, Patrick J, 1993. "Sustainable Plans and Mutual Default," Review of Economic Studies, Wiley Blackwell, vol. 60(1), pages 175-95, January.
  2. Bassetto, Marco, 2005. "Equilibrium and government commitment," Journal of Economic Theory, Elsevier, vol. 124(1), pages 79-105, September.
  3. Gaetano Antinolfi & Elisabeth Huybens, 2000. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Econometric Society World Congress 2000 Contributed Papers 1156, Econometric Society.
  4. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
  5. Ennis, Huberto M. & Keister, Todd, 2005. "Optimal fiscal policy under multiple equilibria," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1359-1377, November.
  6. Champ, B. & Snith, B.D. & Williamson, D.S., 1991. "Currency Elasticity and Banking Panics: Theory and Evidence," RCER Working Papers 292, University of Rochester - Center for Economic Research (RCER).
  7. Engineer, Merwan, 1989. "Bank runs and the suspension of deposit convertibility," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 443-454, November.
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