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Banking Policy without Commitment: Suspension of Convertibility Taken Seriously

  • Huberto M. Ennis

    ()

    (Research Department Federal Reserve Bank of Richmond)

  • Todd Keister

We study banking policy credibility in a variant of the Diamond and Dybvig (JPE, 1983) model. By committing to temporarily close banks during a run, suspending the convertibility of deposits into currency, the banking authority can eliminate the possibility of a bank run as an equilibrium outcome. Without commitment, however, if a run were to actually occur it may not be optimal for the authority to keep its promise to suspend convertibility. In other words, the threat of suspension may not be credible. We derive conditions under which a credible suspension scheme can be used to rule out bank runs and conditions under which it cannot. In the latter case, bank runs can occur even when there is no uncertainty about aggregate liquidity demand. We relate the analysis to events in Argentina in 2001, when a system-wide suspension of convertibility was declared but only partially enforced

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 464.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:464
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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