40 Pages Posted: 15 Sep 2009
Date Written: September 14, 2009
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: 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