Banking, Liquidity and Bank Runs in an Infinite Horizon Economy
We develop a variation of the macroeconomic model of banking in Gertler and Kiyotaki (2011) that allows for household liquidity risks and bank runs as in Diamond and Dybvig (1983). As in Gertler and Kiyotaki, because bank net worth fluctuates with aggregate production, the spread in the expected rates of return on bank asset and deposit fluctuates countercyclically. However, because bank assets have a longer maturity than deposits, bank runs are possible as in Diamond and Dybvig. Whether a bank run equilibrium exists depends on bank balance sheets and a liquidation price for bank assets in equilibrium. While in normal times a bank run equilibrium may not exist, the possibility can arise in a recession. Overall, the goal is to present a framework that synthesizes the macroeconomic and microeconomic approaches to banking and banking instability.
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