Working Paper

Banking panics and protracted recessions

Abstract: This paper develops a dynamic model of bank liquidity provision to characterize the ex post efficient policy response to a banking panic and study its implications for the behavior of output in the aftermath of a panic. It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of this liquidation cost, the recession associated with a banking panic is protracted. For intermediate values, the recession is more severe but short lived. For relatively large values, the contemporaneous decline in real output in the event of a panic is substantial but followed by a vigorous rebound in real activity above the long-run level. The author argues that these theoretical predictions are consistent with the observed disparity in crisis-related output losses.

Keywords: Banking panic; Deposit contract; Suspension of convertibility; Time-consistent policy;

JEL Classification: E32; E42; G21;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2015-10-21

Number: 15-39

Pages: 40 pages