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Financial collapse and active monetary policy: a lesson from the Great Depression
We analyze financial collapses, such as the one that occurred during the U.S. Great Depression, from the perspective of a monetary model with multiple equilibria. The multiplicity arises from the presence of a strategic complementarity due to increasing returns to scale in the intermediation process. Intermediaries provide the link between savers and firms who require working capital for production. Fluctuations in the intermediation process are driven by variations in the confidence agents place in the financial system. From a positive perspective, our model matches closely the qualitative ...
Working Paper
Endogenous realignments and the sustainability of a target
We examine the effects of endogenously determined realignment expectations in a model of a target zone with sluggish price adjustment. We allow these expectations to be based on a policy rule that generates an increasing probability of realignment as output moves away from full employment. We find that for realistic parameter values, even relatively small misalignments of the currency band lead to strongly skewed conditional distributions for the nominal exchange rate, thus generating pressures for realignment. We show that the reason for this is that the speed of adjustment in the absence of ...
Working Paper
On the welfare gains of eliminating a small likelihood of economic crises: A case for stabilization policies?
In this paper the authors estimate the potential benefit of policies that eliminate a small likelihood of economic crises. They define an economic crisis as a Depression-style collapse of economic activity. For the U.S., based on the observed frequency of Depression-like events, the authors estimate the likelihood of encountering a depression to be about once every 83 years. Even for this small probability of moving into a Depression-like state, the welfare gain from setting it to zero can range between 1 and 7 percent of annual consumption, in perpetuity. These estimates are large in ...
Working Paper
A welfare comparison of pre- and post-WWII business cycles: some implications for the role of postwar macroeconomic policies
The authors compute the potential economic benefits that would accrue to a typical pre-WWII era U.S. worker from the post-WWII macroeconomic policy regime. The authors assume that workers face undiversifiable income risk but can self-insure by saving in nominal assets. The worker's average utility is computed for two eras: pre-WWII (1875-1941) and post-WWII. In the pre-WWII era, the worker endured business cycles that were large in amplitude and quite volatile, a procyclical aggregate price level with large cyclical amplitude, a high average unemployment rate, and virtually no trend in the ...
Working Paper
Capital requirements in a quantitative model of banking industry dynamics
We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on bank risk taking, commercial bank failure, and market structure. We propose a market structure where big, dominant banks interact with small, competitive fringe banks. Banks accumulate securities like Treasury bills and undertake short-term borrowing when there are cash flow shortfalls. A nontrivial size distribution of banks arises out of endogenous entry and exit, as well as banks? buffer stocks of securities. We test the model using business cycle properties and the bank lending ...
Working Paper
Monetary and financial forces in the Great Depression
What caused the worldwide collapse in output from 1929 to 1933? Why was the recovery from the trough of 1933 so protracted for the U.S.? How costly was the decline in terms of welfare? Was the decline preventable? These are some of the questions that have motivated economists to study the Great Depression. In this paper, the authors review some of the economic literature that attempts to answer these questions.
Working Paper
Valuation equilibria with transactions costs
Working Paper
Money and finance in a model of costly commitment
Working Paper
Foreign competition and banking industry dynamics: an application to Mexico
The authors develop a simple general equilibrium framework to study the effects of global competition on banking industry dynamics and welfare. They apply the framework to the Mexican banking industry, which underwent a major structural change in the 1990s as a consequence of both government policy and external shocks. Given the high concentration in the Mexican banking industry, domestic and foreign banks act strategically in the authors? framework. After calibrating the model to Mexican data, the authors examine the welfare consequences of government policies that promote global ...
Working Paper
On the welfare gains of reducing the likelihood of economic crises.
The authors' aim in this paper is to obtain a measure of the potential benefit of reducing the likelihood of economic crises. The authors define an economic crisis as a Depression-style collapse of economic activity. Based on the observed frequency of Depression-like events, the authors estimate this likelihood to be approximately once every 83 years for the United States. Even for this small probability of moving into a Depression-like state, the welfare gain from setting it to zero can range between 1.05 percent and 6.59 percent of annual consumption, in perpetuity. These large gains arise ...