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Self-Fulfilling Credit Market Freezes

  • Lucian A. Bebchuk
  • Itay Goldstein

This paper develops a model of a self-fulfilling credit market freeze and uses it to study alternative governmental responses to such a crisis. We study an economy in which operating firms are interdependent, with their success depending on the ability of other operating firms to obtain financing. In such an economy, an inefficient credit market freeze may arise in which banks abstain from lending to operating firms with good projects because of their self-fulfilling expectations that other banks will not be making such loans. Our model enables us to study the effectiveness of alternative measures for getting an economy out of an inefficient credit market freeze. In particular, we study the effectiveness of interest rate cuts, infusion of capital into banks, direct lending to operating firms by the government, and the provision of government capital or guarantees to finance or encourage privately managed lending. Our analysis provides a framework for analyzing and evaluating the standard and nonstandard instruments used by authorities during the financial crisis of 2008-2009.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16031.

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Date of creation: May 2010
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Publication status: published as “Self - Fulfilling Credit Market Freezes,” 24 Review of Financial Studies 3519 - 3555 (2011) 24242321 . (with Itay Goldstein)
Handle: RePEc:nbr:nberwo:16031
Note: CF EFG LE ME
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  1. Carlsson, H. & van Damme, E.E.C., 1993. "Global games and equilibrium selection," Other publications TiSEM 49a54f00-dcec-4fc1-9488-4, Tilburg University, School of Economics and Management.
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  16. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
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