Banks are Where the Liquidity is

36 Pages Posted: 25 Sep 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 show that, 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. 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.

Keywords: bailout, banking, Liquidity

JEL Classification: E41, E51, G21

Suggested Citation

Hart, Oliver D. and Zingales, Luigi, Banks are Where the Liquidity is (June 2014). CEPR Discussion Paper No. DP10017. Available at SSRN: https://ssrn.com/abstract=2501489

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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