High interest rates: the golden rule for bank stability in the Diamond-Dybvig model
In a companion paper, Bertolai et al. (2011) build on Peck-Shell (2003) economies and obtain strong implementation in perturbations of optimal contracts. Since bank runs are eliminated with distortions that become very small when the population grows, a pressing issue is whether an alternative specification can generate the costly crisis that are common in history. We find, in this paper, an affirmative answer in the context of the Diamond-Dybvig (1983) model, and uncover the role played by societal weights on future consumption and solvency risk. An extension of the Ennis-Keister (2009) algorithm shows the impact of run strategies and implicit rates of interest on the formation of expectations, in line with some classical views.
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- Diamond, Douglas W & Dybvig, Philip H, 1983.
"Bank Runs, Deposit Insurance, and Liquidity,"
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- James Peck & Karl Shell, 2003.
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- Cavalcanti, Ricardo de Oliveira & Bertolai, Jefferson Donizeti Pereira & Monteiro, P. K., 2011. "A note on convergence of Peck-Shell and Green-Lin mechanisms in the Diamond-Dybvig model," Economics Working Papers (Ensaios Economicos da EPGE) 722, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- Ennis, Huberto M. & Keister, Todd, 2009. "Run equilibria in the Green-Lin model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 144(5), pages 1996-2020, September.
- Cavalcanti, Ricardo de Oliveira & Monteiro, P. K., 2011. "Enriching information to prevent bank runs," Economics Working Papers (Ensaios Economicos da EPGE) 721, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- Andolfatto, David & Nosal, Ed & Wallace, Neil, 2007.
"The role of independence in the Green-Lin Diamond-Dybvig model,"
Journal of Economic Theory,
Elsevier, vol. 137(1), pages 709-715, November.
- David Andolfatto & Ed Nosal & Neil Wallace, 2006. "The role of independence in the Green-Lin Diamond-Dybvig model," Working Paper 0615, Federal Reserve Bank of Cleveland.
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