Pecuniary Externalities, Bank Overleverage, and Macroeconomic Fragility

ISER DP No. 1078, March 2020

33 Pages Posted: 16 Mar 2020

See all articles by Ryo Kato

Ryo Kato

Asia University; TCER

Takayuki Tsuruga

Osaka University, Institute of Social and Economic Research

Date Written: March 9, 2020

Abstract

Pecuniary externalities in models with financial friction justify macroprudential policies for preventing economic agents’ excessive risk taking. We extend the Diamond and Rajan (2012) model of banks with the production factors and explore how a pecuniary externality affects a bank’s leverage. We show that the laissez-faire banks in our model take on excessive risks compared with the constrained social optimum. Our numerical simulations suggest that the crisis probability is 2-3 percentage points higher in the laissez-faire economy than in the constrained social optimum.

Keywords: Financial crisis, Liquidity shortage, Maturity mismatch, Credit

JEL Classification: E3, G01, G21

Suggested Citation

Kato, Ryo and Tsuruga, Takayuki, Pecuniary Externalities, Bank Overleverage, and Macroeconomic Fragility (March 9, 2020). ISER DP No. 1078, March 2020, Available at SSRN: https://ssrn.com/abstract=3551826 or http://dx.doi.org/10.2139/ssrn.3551826

Ryo Kato

Asia University ( email )

5-8 Sakai, Musashisno
Tokyo, 1808629
Japan

TCER ( email )

Sankyo Building
Room 703, Main Building
Chiyoda-ku, Tokyo, 1-7-10
Japan

Takayuki Tsuruga (Contact Author)

Osaka University, Institute of Social and Economic Research ( email )

6-1 Mihogaoka
Ibaraki, 567-0047
Japan

HOME PAGE: http://www.iser.osaka-u.ac.jp/~tsuruga/

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