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Anatomy of a Financial Crisis

  • Frederic S. Mishkin

This paper provides an asymmetric information framework for understanding the nature of financial crises. It provides the following precise definition of a financial crisis: A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities. As a result, a financial crisis can drive the economy away from an equilibrium with high output in which financial markets perform well to one in which output declines sharply. The asymmetric information framework explains the patterns in the data and many features of these crises which are otherwise hard to explain. It indicates that financial crises have effects over and above those resulting from bank panics and therefore provides a rationale for an expanded lender-of-last resort role for the central bank in which the central bank uses the discount window to provide liquidity to sectors outside of the banking system.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3934.

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Date of creation: Dec 1991
Date of revision:
Publication status: published as Journal of Evolutionary Economics, 2, pp. 115-130 (1992).
Handle: RePEc:nbr:nberwo:3934
Note: ME
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  1. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
  2. Mark Gertler, 1988. "Financial structure and aggregate economic activity: an overview," Proceedings, Federal Reserve Bank of Cleveland, pages 559-596.
  3. Stiglitz, Joseph E & Weiss, Andrew, 1983. "Incentive Effects of Terminations: Applications to the Credit and Labor Markets," American Economic Review, American Economic Association, vol. 73(5), pages 912-27, December.
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