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A model to analyse financial fragility

  • Charles Goodhart
  • Pojanart Sunirand
  • Dimitrios Tsomocos


This paper sets out a tractable model which illuminates problems relating to individual bank behaviour, 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 heterogeneous agents, endogenous default, and multiple commodity, and credit and deposit markets. Yet, it is simple enough to be effectively computable and can therefore be used as a practical framework to analyse financial fragility. Financial fragility in our model emerges naturally as an equilibrium phenomenon. Among other results, 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 and economic efficiency. Copyright Springer-Verlag Berlin/Heidelberg 2006

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Article provided by Springer in its journal Economic Theory.

Volume (Year): 27 (2006)
Issue (Month): 1 (01)
Pages: 107-142

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Handle: RePEc:spr:joecth:v:27:y:2006:i:1:p:107-142
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  1. Dimitrios P. Tsomocos, 2003. "Equilibrium Analysis, Banking and Financial Instability," OFRC Working Papers Series 2003fe08, Oxford Financial Research Centre.
  2. Tobin, James, 1982. " The Commercial Banking Firm: A Simple Model," Scandinavian Journal of Economics, Wiley Blackwell, vol. 84(4), pages 495-530.
  3. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
  4. repec:oup:restud:v:72:y:2005:i:1:p:223-246 is not listed on IDEAS
  5. Charles Goodhart, 1989. "Money, Information and Uncertainty: 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262071223, June.
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