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Financial crises and economic growth

Robert Jarrow ()

The Quarterly Review of Economics and Finance, 2014, vol. 54, issue 2, 194-207

Abstract: This paper constructs a simple yet robust model of financial crises and economic growth where financial markets affect real economic activity. Financial markets increase real output by facilitating investment through the borrowing/lending of capital. However, the borrowing of capital is risky due to randomness in the firms’ production. Financial crises occur when output and liquid capital are insufficient to meet required loan payments and systemic defaults occur. In this model, a financial crisis caused by systemic defaults can shift the economy from an equilibrium with positive borrowing/lending to an equilibrium with no borrowing/lending. In this no-lending equilibrium, neither traditional fiscal or monetary policy tools are effective in increasing output. Fiscal and monetary policy can only increase the likelihood of the equilibrium evolving to a borrowing/lending equilibrium.

Keywords: Credit risk; Economic growth; Equilibrium; Stochastic production (search for similar items in EconPapers)
JEL-codes: E22 E23 E43 E44 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:54:y:2014:i:2:p:194-207

DOI: 10.1016/j.qref.2013.12.001

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