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Financial crises and economic growth

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  • Jarrow, Robert A.

Abstract

This paper constructs a simple yet robust model of financial crises and economic growth where financial markets affect real economic activity. Financial markets increase real output by facilitating investment through the borrowing/lending of capital. However, the borrowing of capital is risky due to randomness in the firms’ production. Financial crises occur when output and liquid capital are insufficient to meet required loan payments and systemic defaults occur. In this model, a financial crisis caused by systemic defaults can shift the economy from an equilibrium with positive borrowing/lending to an equilibrium with no borrowing/lending. In this no-lending equilibrium, neither traditional fiscal or monetary policy tools are effective in increasing output. Fiscal and monetary policy can only increase the likelihood of the equilibrium evolving to a borrowing/lending equilibrium.

Suggested Citation

  • Jarrow, Robert A., 2014. "Financial crises and economic growth," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(2), pages 194-207.
  • Handle: RePEc:eee:quaeco:v:54:y:2014:i:2:p:194-207 DOI: 10.1016/j.qref.2013.12.001
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    References listed on IDEAS

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    Cited by:

    1. Zeeshan Atiq & M. Emranul Haque, 2015. "Financial Development and Economic Growth: The Role of Financial Liberalization," Centre for Growth and Business Cycle Research Discussion Paper Series 201, Economics, The Univeristy of Manchester.

    More about this item

    Keywords

    Credit risk; Economic growth; Equilibrium; Stochastic production;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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