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Banking Panics and Output Dynamics

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  • Daniel R. Sanches

Abstract

This paper develops a dynamic general equilibrium model with an essential role for an illiquid banking system to investigate output dynamics in the event of a banking crisis. In particular, it considers the ex-post efficient policy response to a banking crisis as part of the dynamic equilibrium analysis. It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of the liquidation cost, the recession associated with a banking panic is protracted as a result of the premature liquidation of a large fraction of productive banking assets to respond to a panic. For intermediate values, the recession is more severe but short-lived. For relatively large values, the contemporaneous decline in real output in the event of a panic is substantial but followed by a vigorous rebound in real activity above the long-run level.

Suggested Citation

  • Daniel R. Sanches, 2017. "Banking Panics and Output Dynamics," Working Papers 17-20, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:17-20
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Banking Panics and Output Dynamics
      by Christian Zimmermann in NEP-DGE blog on 2017-09-01 19:50:31

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    More about this item

    Keywords

    Banking panic; deposit contract; suspension of convertibility; time-consistent policies;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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