Financial Crisis Resolution

Josef Schroth

No 617, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies a dynamic version of the Holmstrom-Tirole model of intermediated finance. I show that competitive equilibria are inefficient when the economy experiences a financial crises. A pecuniary externality entails that bank back-loading may weaken bank incentives. I show that a constrained social planner finds it beneficial to introduce a permanent wedge between the deposit rate and the economy's marginal rate of transformation. The wedge improves borrowers' access to finance during a financial crisis by strengthening banks' incentives to provide intermediation services. I propose a simple implementation of the constrained-efficient allocation that limits bank size.

Date: 2012
New Economics Papers: this item is included in nep-dge
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Working Paper: Financial Crisis Resolution (2012)
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