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Financial Crisis Resolution

  • 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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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
Date of revision:
Handle: RePEc:bca:bocawp:12-42
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