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Economic growth, liquidity, and bank runs

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Abstract

We construct an endogenous growth model in which bank runs occur with positive probability in equilibrium. In this setting, a bank run has a permanent effect on the levels of the capital stock and of output. In addition, the possibility of a run changes the portfolio choices of depositors and of banks, and thereby affects the long-run growth rate. These facts imply that both the occurrence of a run and the mere possibility of runs in a given period have a large impact on all future periods. A bank run in our model is triggered by sunspots, and we consider two different equilibrium selection rules. In the first, a run occurs with a fixed, exogenous probability, while in the second the probability of a run is influenced by banks' portfolio choices. We show that when the choices of an individual bank affect the probability of a run on that bank, the economy both grows faster and experiences fewer runs.

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  • Huberto M. Ennis & Todd Keister, 2003. "Economic growth, liquidity, and bank runs," Working Paper 03-01, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:03-01
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    Keywords

    Banks and banking; Equilibrium (Economics);

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