Delayed Crises and Slow Recoveries

65 Pages Posted: 31 Mar 2020 Last revised: 8 Jun 2020

See all articles by Xuewen Liu

Xuewen Liu

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics

Pengfei Wang

HKUST, Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Zhongchao Yang

Hong Kong University of Science & Technology (HKUST) - Department of Economics

Date Written: November 1, 2019

Abstract

We present a rational expectations model of credit-driven crises, providing a new perspective to explain why credit booms can lead to severe financial crises and aftermath slow economic recoveries. In our model economy, banks can operate in two types of business à la Minsky's narratives. They are sequentially aware of the deterioration of fundamentals of the speculative business and decide whether to continue credit extension in that business or liquidate capital and move into the traditional business. However, because individual banks face uncertainty about how many of their peers have been aware, they rationally choose to extend credit in the speculative business for a longer time than is socially optimal, leading to an over-delayed crisis and consequently more banks being caught by the crisis. This in turn renders the financial crisis more severe and the subsequent economic recovery slower. Within a standard textbook macroeconomic growth setting, our model generates rich dynamics of economic booms, slowdowns, crashes, and recoveries.

Suggested Citation

Liu, Xuewen and Wang, Pengfei and Yang, Zhongchao, Delayed Crises and Slow Recoveries (November 1, 2019). Available at SSRN: https://ssrn.com/abstract=3558492 or http://dx.doi.org/10.2139/ssrn.3558492

Xuewen Liu (Contact Author)

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

HOME PAGE: http://web.hku.hk/~xuewenl/

Pengfei Wang

HKUST, Department of Economics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

Zhongchao Yang

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

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