A Model to Analyse Financial Fragility

33 Pages Posted: 11 Mar 2005

See all articles by Charles Goodhart

Charles Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group

Pojanart Sunirand

London School of Economics & Political Science (LSE) - Department of Economics

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Abstract

This paper sets out a tractable model which illuminates problems relating to individual bank behaviour, to possible contagious inter-relationships between banks, and to the appropriate design of prudential requirements and incentives to limit 'excessive' risk-taking. Our model is rich enough to include heterogeneous agents, endogenous default, and multiple commodity, and credit and deposit markets. Yet, it is simple enough to be effectively computable and can therefore be used as a practical framework to analyse financial fragility. Financial fragility in our model emerges naturally as an equilibrium phenomenon. Among other results, a non-trivial quantity theory of money is derived, liquidity and default premia co-determine interest rates, and both regulatory and monetary policies have non-neutral effects. The model also indicates how monetary policy may affect financial fragility, thus highlighting the trade-off between financial stability and economic efficiency.

Keywords: Financial fragility, commerical banks, general equilibrium, default, incomplete markets, monetary policy, regulatory policy

JEL Classification: D52, E4, E5, G11, G21

Suggested Citation

Goodhart, Charles A.E. and Sunirand, Pojanart and Tsomocos, Dimitrios P., A Model to Analyse Financial Fragility. Economic Theory, Forthcoming. Available at SSRN: https://ssrn.com/abstract=676830

Charles A.E. Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
0207 955 7555 (Phone)
0207 242 1006 (Fax)

Pojanart Sunirand

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
Room S182
London WC2A 2AE
United Kingdom
+44(0)20-7955-6993 (Phone)

Dimitrios P. Tsomocos (Contact Author)

University of Oxford - Said Business School and St. Edmund Hall ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288 932 (Phone)
+44 1865 288 805 (Fax)

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