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The 'Surprising' Origin and Nature of Financial Crises:
A Macroeconomic Policy Proposal

40 Pages Posted: 15 Sep 2009  

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Pablo D. Kurlat

Stanford University - Department of Economics

Date Written: September 14, 2009

Abstract

Severe financial crises in developed economies are produced by a combination of three factors: negative surprises that create uncertainty, concentration of macroeconomic risk in leveraged financial institutions and a slow policy response. We propose a policy instrument, Tradable Insurance Credits (TICs), designed to address crises stemming from these factors. TICs would be issued by the central bank and give their holder the right to attach a central bank guarantee to assets on its balance sheet, but only during a financial crisis; financial institutions would be required to keep a minimum holding of TICs. TIC policy could be carried out in a similar way to monetary policy and fits into existing institutional frameworks; we examine how TICs could have been used to address the 2007-2009 financial crisis in a faster and more systematic way than the ad-hoc measures undertaken.

Keywords: financial crises, Knightian uncertainty, macroeconomic risk, credit default swaps, asset insurance

JEL Classification: G01, G28, E58

Suggested Citation

Caballero, Ricardo J. and Kurlat, Pablo D., The 'Surprising' Origin and Nature of Financial Crises: A Macroeconomic Policy Proposal (September 14, 2009). MIT Department of Economics Working Paper No. 09-24. Available at SSRN: https://ssrn.com/abstract=1473918 or http://dx.doi.org/10.2139/ssrn.1473918

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Building E52-528
Cambridge, MA 02142
United States
617-253-0489 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pablo D. Kurlat

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

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