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Anatomy of a Financial Crisis

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  • Frederic S. Mishkin

Abstract

This paper provides an asymmetric information framework for understanding the nature of financial crises. It provides the following precise definition of a financial crisis: A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities. As a result, a financial crisis can drive the economy away from an equilibrium with high output in which financial markets perform well to one in which output declines sharply. The asymmetric information framework explains the patterns in the data and many features of these crises which are otherwise hard to explain. It indicates that financial crises have effects over and above those resulting from bank panics and therefore provides a rationale for an expanded lender-of-last resort role for the central bank in which the central bank uses the discount window to provide liquidity to sectors outside of the banking system.

Suggested Citation

  • Frederic S. Mishkin, 1991. "Anatomy of a Financial Crisis," NBER Working Papers 3934, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3934
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    References listed on IDEAS

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    1. Mark Gertler, 1988. "Financial structure and aggregate economic activity: an overview," Proceedings, Federal Reserve Bank of Cleveland, pages 559-596.
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