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Strategic Complementarities and the Twin Crises

  • Itay Goldstein
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    The economic literature emphasised the role of strategic complementarities in generating banking crises and currency crises. Motivated by evidence from recent financial crises, we study a model, where strategic complementarities exist, not only within a group of creditors or within a group of currency speculators, but also between the two groups. The additional type of complementarities generates a vicious circle between banking crises and currency crises. This magnifies the correlation between the two crises and destabilises the economy. We show that, due to the vicious circle, a Lender of Last Resort might not be able to prevent bank runs. Copyright 2005 Royal Economic Society.

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    Article provided by Royal Economic Society in its journal The Economic Journal.

    Volume (Year): 115 (2005)
    Issue (Month): 503 (04)
    Pages: 368-390

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    Handle: RePEc:ecj:econjl:v:115:y:2005:i:503:p:368-390
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    1. Itay Goldstein & Ady Pauzner, 2005. "Demand-Deposit Contracts and the Probability of Bank Runs," Journal of Finance, American Finance Association, vol. 60(3), pages 1293-1327, 06.
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    9. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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    11. Nancy Marion, 1999. "Some Parallels Between Currency and Banking Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 473-490, November.
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    15. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
    16. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
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