Financial system: shock absorber or amplifier?

Franklin Allen and Elena Carletti ()

No 257, BIS Working Papers from Bank for International Settlements

Abstract: This paper identifies two types of market failures. The first concerns a coordination problem associated with panics. The problem in analysing this type of market failure from a policy perspective is that there is no widely accepted method for selecting equilibria. The second market failure concerns the incompleteness of financial markets. The essential problem here is that the incentives to provide liquidity lead to an inefficient allocation of resources. The paper outlines three manifestations of market failure associated with liquidity provision: financial fragility, contagion and asset price bubbles. The framework developed allows some insight into the question of when the financial system acts a shock absorber and when it acts as an amplifier. Having identified when there is a market failure, the paper looks at whether there are policies that can correct the undesirable effects of such failures.

Keywords: bank regulation; financial crisis; financial intermediation; market failure (search for similar items in EconPapers)
Pages: 26 pages
Date: 2008-07
New Economics Papers: this item is included in nep-fmk, nep-pke and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:257

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