Banks Are Where the Liquidity Is
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); University of Chicago - Polsky Center for Entrepreneurship; European Corporate Governance Institute (ECGI)
May 1, 2014
Chicago Booth Research Paper No. 14-27
Fama-Miller Working Paper
What is so special about banks that their demise often triggers government intervention? In this paper we show that, even ignoring interconnectedness issues, the failure of a bank causes a larger welfare loss than the failure of other institutions. The reason is that agents in need of liquidity tend to concentrate their holdings in banks. Thus, a shock to banks disproportionately affects the agents who need liquidity the most, reducing aggregate demand and the level of economic activity. The optimal fiscal response to such a shock is to help people, not banks, and the size of this response should be larger if a bank, rather than a similarly-sized nonfinancial firm, fails.
Number of Pages in PDF File: 41
Keywords: liquidity, bailout, banking
JEL Classification: E41 G21, E51
Date posted: July 26, 2014
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