Banks are Where the Liquidity is

41 Pages Posted: 16 Jun 2014

See all articles by Oliver Hart

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Luigi Zingales

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: June 2014

Abstract

What is so special about banks that their demise often triggers government intervention? In this paper we develop a simple model where, even ignoring interconnectedness issues, the failure of a bank causes a larger welfare loss than the failure of other institutions. The reason is that agents in need of liquidity tend to concentrate their holdings in banks. Thus, a shock to banks disproportionately affects the agents who need liquidity the most, reducing aggregate demand and the level of economic activity. In the context of our model, the optimal fiscal response to such a shock is to help people, not banks, and the size of this response should be larger if a bank, rather than a similarly-sized nonfinancial firm, fails.

Suggested Citation

Hart, Oliver D. and Zingales, Luigi, Banks are Where the Liquidity is (June 2014). NBER Working Paper No. w20207. Available at SSRN: https://ssrn.com/abstract=2450908

Oliver D. Hart (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Luigi Zingales

University of Chicago - Booth School of Business ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

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