Banking panics and protracted recessions

Daniel Sanches

No 14-37, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: This paper develops a dynamic theory of money and banking that explains why banks need to hold an illiquid portfolio to provide socially optimal transaction and liquidity services, opening the door to the possibility of equilibrium banking panics. Following a widespread liquidation of banking assets in the event of a panic, the banking portfolio consistent with the optimal provision of transaction and liquidity services during normal times cannot be quickly reestablished, resulting in an unusual loss of wealth for all depositors. This negative wealth effect stemming from the liquid portion of the consumers' portfolio is strong enough to produce a protracted recession. A key element of the theory is the existence of a dynamic interaction between the ability of banks to offer transaction and liquidity services and the occurrence of panics.

Keywords: Banking Panics; Medium Of Exchange; Random Matching; Transaction Services; Liquidity Insurance (search for similar items in EconPapers)
JEL-codes: E32 E42 G21 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2014-12-22
New Economics Papers: this item is included in nep-ban, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Working Paper: Banking panics and protracted recessions (2015)
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