Delayed Crises and Slow Recoveries

59 Pages Posted: 31 Mar 2020 Last revised: 17 Feb 2023

See all articles by Xuewen Liu

Xuewen Liu

University of Hong Kong (HKU), HKU Business School

Pengfei Wang

Peking University HSBC Business School

Zhongchao Yang

Wuhan University - Economics and Management School

Date Written: February 16, 2023

Abstract

We present a rational expectations model of credit-driven crises, providing a new perspective to explain why credit booms can lead to severe financial crises and aftermath slow economic recoveries. In the Keynes' game of musical chairs, banks can operate in two types of business à la Minsky's narratives. They are sequentially aware of the deterioration of fundamentals of the speculative business and decide whether to continue credit extension in that business or liquidate capital and move into the traditional business. However, because individual banks face uncertainty about how many of their peers have been aware, they rationally choose to extend credit in the speculative business for a longer time than is socially optimal, leading to an over-delayed crisis and consequently more banks being caught by the crisis. This in turn renders the financial crisis more severe and the subsequent economic recovery slower. Within a standard textbook macroeconomic growth setting, our model generates rich dynamics of economic booms, slowdowns, crashes, and recoveries.

Suggested Citation

Liu, Xuewen and Wang, Pengfei and Yang, Zhongchao, Delayed Crises and Slow Recoveries (February 16, 2023). Available at SSRN: https://ssrn.com/abstract=3558492 or http://dx.doi.org/10.2139/ssrn.3558492

Xuewen Liu (Contact Author)

University of Hong Kong (HKU), HKU Business School ( email )

Pokfulam Road
Hong Kong
China

HOME PAGE: http://xuewenliu.com/

Pengfei Wang

Peking University HSBC Business School ( email )

Zhongchao Yang

Wuhan University - Economics and Management School ( email )

Hubei
China

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