Amplification Mechanisms in Liquidity Crises

Arvind Krishnamurthy

No 15040, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: I describe two amplifications mechanisms that operate during liquidity crises and discuss the scope for central bank policies during crises as well as preventive policies in advance of crises. The first mechanism works through asset prices and balance sheets. A negative shock to the balance sheets of asset-holders causes them to liquidate assets, lowering prices, further deteriorating balance sheets, culminating in a crisis. The second mechanism involves investors' Knightian uncertainty. Unusual shocks to untested financial innovations lead agents to become uncertain about their investments causing them to disengage from markets and increase their demand for liquidity. This behavior leads to a loss of liquidity and a crisis.

JEL-codes: G01 G18 G2 (search for similar items in EconPapers)
Date: 2009-06
Note: AP CF ME
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Citations: View citations in EconPapers (32)

Published as Arvind Krishnamurthy, 2010. "Amplification Mechanisms in Liquidity Crises," American Economic Journal: Macroeconomics, vol 2(3), pages 1-30.

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Journal Article: Amplification Mechanisms in Liquidity Crises (2010)
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