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On the Instability of Banking and Financial Intermediation

Author

Listed:
  • Chao Gu

    (University of Missouri)

  • Cyril Monnet

    (University of Berne)

  • Ed Nosal

    (FRB Atlanta)

  • Randall Wright

    (University of Wisconsin)

Abstract

Are financial intermediaries inherently unstable? If so, why? What does this suggest about government intervention? To address these issues we analyze whether model economies with financial intermediation are particularly prone to multiple, cyclic, or stochastic equilibria. Four formalizations are considered: a dynamic version of Diamond-Dybvig incorporating reputational considerations; a model with delegated monitoring as in Diamond; one with bank liabilities serving as payment instruments similar to currency in Lagos-Wright; and one with Rubinstein-Wolinsky intermediaries in a decentralized asset market as in Duffie et al. In each case we find, for different reasons, that financial intermediation engenders instability in a precise sense.

Suggested Citation

  • Chao Gu & Cyril Monnet & Ed Nosal & Randall Wright, 2019. "On the Instability of Banking and Financial Intermediation," Working Papers 1901, Department of Economics, University of Missouri.
    • Handle: RePEc:umc:wpaper:1901
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    2. Altermatt, Lukas & van Buggenum, Hugo & Voellmy, Lukas, 2024. "Systemic bank runs without aggregate risk: How a misallocation of liquidity may trigger a solvency crisis," Journal of Financial Economics, Elsevier, vol. 161(C).
    3. Heon Lee, 2023. "On the Instability of Fractional Reserve Banking," Papers 2305.14503, arXiv.org, revised Apr 2024.
    4. Makoto WATANABE & Tarishi Matsuoka, 2023. "A Monetary Equilibrium with the Lender of Last Resort," CIGS Working Paper Series 23-010E, The Canon Institute for Global Studies.
    5. Williamson, Stephen D., 2022. "Central bank digital currency and flight to safety," Journal of Economic Dynamics and Control, Elsevier, vol. 142(C).
    6. James Peck & Abolfazi Setayesh, 2023. "Bank Runs and the Optimality of Limited Banking," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 100-110, January.

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    More about this item

    Keywords

    Banking; Financial Intermediation; Instability; Volatility;
    All these keywords.

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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