Anticipated Banking Panics (with Mark Gertler and Nobu Kiyotaki)
A
bstract:
We develop a macroeconomic model with banking instability. S
unspot runs can arise that are harmful to the economy. However, whether a r
un equilibrium exists depends on fundamentals. In contrast to earlier work,
the probability of a sunspot run is the outcome of rational forecast based
on fundamentals. The model captures the movement from slow to fast runs th
at was a feature of the Great Recession: A weakening of banks’ balance shee
ts increases the probability of a run, leading depositors to withdraw funds
from banks. These slow runs have harmful effects on the economy and set th
e stage for fast runs. We then turn to study optimal leverage restrictions
in this setup. The optimal policy corrects both traditional pecuniary exter
nalities and a new type of externality arising from agents’ failure to fact
or in the effect of their leverage choices on the probability of a systemic
run. We study the interaction and relative quantitative importance of pecu
niary externalities and this “run externality”.