Equilibrium Analysis, Banking, Contagion and Financial Fragility
AbstractThis paper contains a General Equilibrium model of an economy with Incomplete Markets (GEI) with money and default. The model is a simplified version of the real world consisting of a non-bank private sector, banks, a Central Bank, a government and a regulator. The model is used to analyse actions by policy makers and to identify policy relevant empirical work. Key analytical results are: A financially fragile system need not collapse; efficiency can be improved with policy intervention; and that a system with heterogeneous banks is more stable than one with homogeneous ones. Existence of monetary equilibria allows for positive default levels in equilibrium. It also characterises contagion and financial fragility as an equilibrium phenomenon. A definition of financial fragility is proposed. Financial fragility occurs when aggregate profitability of the banking sector declines and defaults in the non-bank private and the banking sectors increase. Thus, equilibria with financial fragility require financial vulnerability in the banking sector and liquidity shortages in the non-bank private sector. The model will be used as a basis to carry out empirical work on the costs of financial instability, to quantify the effectiveness of particular regulatory tools such as capital requirements, and to identify tradeoffs between increasing stability through action by authorities and the efficiency of the financial system.
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Bibliographic InfoPaper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2003fe03.
Date of creation: 2003
Date of revision:
Financial fragility; contagion; competitive banking; capital requirements; incomplete markets; default;
Other versions of this item:
- Dimitrios P Tsomocos, 2003. "Equilibrium analysis, banking, contagion and financial fragility," Bank of England working papers 175, Bank of England.
- Dimitrios Tsomocos, 2003. "Equilibrium analysis, banking, contagion and financial fragility," FMG Discussion Papers dp450, Financial Markets Group.
- D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G1 - Financial Economics - - General Financial Markets
- G2 - Financial Economics - - Financial Institutions and Services
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-06-04 (All new papers)
- NEP-CBA-2003-06-04 (Central Banking)
- NEP-CFN-2003-06-04 (Corporate Finance)
- NEP-FIN-2003-06-04 (Finance)
- NEP-MFD-2003-06-04 (Microfinance)
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