Financial Innovation, Macroeconomic Stability and Systemic Crises
41 Pages Posted: 31 Mar 2008
Date Written: February 2008
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 captures the spillovers associated with asset fire sales during periods of stress. If a sufficiently severe shock occurs during a credit expansion, these spillovers can potentially generate 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.
Keywords: Systemic financial crises, financial innovation, macroeconomic stability, modern financial systems, fire sales
JEL Classification: E32, E44, G13, G2
Suggested Citation: Suggested Citation