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Banking panics and deflation in dynamic general equilibrium

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Abstract

This paper develops a framework to study the interaction between banking, price dynamics, and monetary policy. Deposit contracts are written in nominal terms: if prices unexpectedly fall, the real value of banks' existing obligations increases. Banks default, panics precipitate, economic activity declines. If banks default, aggregate demand for cash increases because financial intermediation provided by banks disappears. When money supply is unchanged, the price level drops, thereby providing incentives for banks to default. Active monetary policy prevents banks from failing and output from falling. Deposit insurance can achieve the same goal but amplifies business cycle fluctuations by inducing moral hazard.

Suggested Citation

  • Francesca Carapella, 2015. "Banking panics and deflation in dynamic general equilibrium," Finance and Economics Discussion Series 2015-18, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2015-18
    DOI: 10.17016/FEDS.2015.018
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    Cited by:

    1. Roberto Robatto, 2019. "Systemic Banking Panics, Liquidity Risk, and Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 34, pages 20-42, October.
    2. Roberto Robatto, 2018. "Flight to Liquidity and Systemic Bank Runs," 2018 Meeting Papers 276, Society for Economic Dynamics.
    3. Roberto Robatto, 2015. "Financial Crises and Systemic Bank Runs in a Dynamic Model of Banking," 2015 Meeting Papers 483, Society for Economic Dynamics.
    4. Robatto, Roberto, 2017. "Flight to liquidity and systemic bank runs," ESRB Working Paper Series 38, European Systemic Risk Board.

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    More about this item

    Keywords

    banking panics; deflation; deposit insurance;
    All these keywords.

    JEL classification:

    • E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • N12 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - U.S.; Canada: 1913-

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