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Financial Crisis Resolution

Listed author(s):
  • Josef Schroth

This paper studies a dynamic version of the Holmstrom-Tirole model of intermediated finance. I show that competitive equilibria are not constrained efficient when the economy experiences a financial crisis. A pecuniary externality entails that banks’ desire to accumulate capital over time aggravates the scarcity of informed capital during the financial crisis. I show that a constrained social planner finds it beneficial to introduce a permanent wedge between the deposit rate and the economy’s marginal rate of transformation. The wedge improves borrowers’ access to finance during a financial crisis by strengthening banks’ incentives to provide intermediation services. I propose a simple implementation of the constrained-efficient allocation that limits bank size.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2012/12/wp2012-42.pdf
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Paper provided by Bank of Canada in its series Staff Working Papers with number 12-42.

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Length: 25 pages
Date of creation: 2012
Handle: RePEc:bca:bocawp:12-42
Contact details of provider: Postal:
234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada

Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/

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