Financial Innovation, Macroeconomic Stability and Systemic Crises

26 Pages Posted: 26 Feb 2008

See all articles by Prasanna Gai

Prasanna Gai

Bank of England

Sujit Kapadia

European Central Bank (ECB); Bank of England

Stephen Millard

Bank of England

Ander Perez-Orive

Federal Reserve Board

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Date Written: 0000

Abstract

We present a general equilibrium model of intermediation designed to capture some of the key features of the modern financial system. The model incorporates financial constraints and state-contingent contracts, and contains a clearly defined pecuniary externality associated with asset fire sales during periods of stress. If a sufficiently severe shock occurs during a credit expansion, this externality is capable of generating a systemic financial crisis that may be self-fulfilling. Our model suggests that financial innovation and greater macroeconomic stability may have made financial crises in developed countries less likely than in the past but potentially more severe.

Suggested Citation

Gai, Prasanna and Kapadia, Sujit and Millard, Stephen and Perez-Orive, Ander, Financial Innovation, Macroeconomic Stability and Systemic Crises (0000). The Economic Journal, Vol. 118, Issue 527, pp. 401-426, March 2008. Available at SSRN: https://ssrn.com/abstract=1096380 or http://dx.doi.org/10.1111/j.1468-0297.2007.02127.x

Prasanna Gai (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
+020 7601 3583 (Phone)

Sujit Kapadia

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
020-7601-5507 (Phone)

Stephen Millard

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Ander Perez-Orive

Federal Reserve Board ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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