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Banks Are Where The Liquidity Is

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  • Oliver Hart
  • Luigi Zingales

Abstract

What is so special about banks that their demise often triggers government intervention? In this paper we develop a simple model where, even ignoring interconnectedness issues, the failure of a bank causes a larger welfare loss than the failure of other institutions. The reason is that agents in need of liquidity tend to concentrate their holdings in banks. Thus, a shock to banks disproportionately affects the agents who need liquidity the most, reducing aggregate demand and the level of economic activity. In the context of our model, the optimal fiscal response to such a shock is to help people, not banks, and the size of this response should be larger if a bank, rather than a similarly-sized nonfinancial firm, fails.

Suggested Citation

  • Oliver Hart & Luigi Zingales, 2014. "Banks Are Where The Liquidity Is," NBER Working Papers 20207, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:20207
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    References listed on IDEAS

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    1. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2012. "The Aggregate Demand for Treasury Debt," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 233-267.
    2. Hanson, Samuel G. & Shleifer, Andrei & Stein, Jeremy C. & Vishny, Robert W., 2015. "Banks as patient fixed-income investors," Journal of Financial Economics, Elsevier, vol. 117(3), pages 449-469.
    3. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    4. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," American Economic Review, American Economic Association, vol. 98(1), pages 358-393, March.
    5. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
    6. Stephen A. Ross, 1976. "Options and Efficiency," The Quarterly Journal of Economics, Oxford University Press, vol. 90(1), pages 75-89.
    7. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-1400, September.
    8. Gary B. Gorton & Guillermo Ordoñez, 2013. "The Supply and Demand for Safe Assets," NBER Working Papers 18732, National Bureau of Economic Research, Inc.
    9. Sharpe, Steven A, 1990. " Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships," Journal of Finance, American Finance Association, vol. 45(4), pages 1069-1087, September.
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    Cited by:

    1. Robert J. Barro & Jesús Fernández-Villaverde & Oren Levintal & Andrew Mollerus, 2014. "Safe Assets," NBER Working Papers 20652, National Bureau of Economic Research, Inc.
      • Barro, Robert J. & Fern�ndez-Villaverde, Jes�s & Levintal, Oren & Mollerus, Andrew, 2017. "Safe Assets," CEPR Discussion Papers 12043, C.E.P.R. Discussion Papers.
      • Robert Barro & Jesus Fernandez-Villaverde & Oren Levintal & Andrew Mollerus, 2017. "Safe Assets," PIER Working Paper Archive 17-008, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 10 May 2017.
    2. Brown, Kareen & Jha, Ranjini & Pacharn, Parunchana, 2015. "Ex ante CEO severance pay and risk-taking in the financial services sector," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 111-126.
    3. repec:sip:dpaper:15-010 is not listed on IDEAS
    4. Ye Li, 2018. "Fragile New Economy: The Rise of Intangible Capital and Financial Instability," 2018 Meeting Papers 1189, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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