Banking panics and deflation in dynamic general equilibrium

Francesca Carapella

No 2015-18, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper develops a framework to study the interaction between banking, price dynamics, and monetary policy. Deposit contracts are written in nominal terms: if prices unexpectedly fall, the real value of banks' existing obligations increases. Banks default, panics precipitate, economic activity declines. If banks default, aggregate demand for cash increases because financial intermediation provided by banks disappears. When money supply is unchanged, the price level drops, thereby providing incentives for banks to default. Active monetary policy prevents banks from failing and output from falling. Deposit insurance can achieve the same goal but amplifies business cycle fluctuations by inducing moral hazard.

Keywords: banking panics; deflation; deposit insurance (search for similar items in EconPapers)
JEL-codes: E53 E58 G21 N12 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2015-03-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ias, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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http://www.federalreserve.gov/econresdata/feds/2015/files/2015018pap.pdf Full text (application/pdf)
http://dx.doi.org/10.17016/FEDS.2015.018 http://dx.doi.org/10.17016/FEDS.2015.018 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2015-18

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