Banks, Liquidity Crises and Economic Growth

UPF Economics and Business Working Paper 853

52 Pages Posted: 30 Nov 2005

See all articles by Alejandro Gaytan

Alejandro Gaytan

Banco de Mexico, Macrofinancial Analysis Division

Romain G. Rancière

University of Southern California

Date Written: August 2001

Abstract

How do the liquidity functions of banks affect investment and growth at different stages of economic development? How do financial fragility and the costs of banking crises evolve with the level of wealth of countries? We analyze these issues using an overlapping generations growth model where agents, who experience idiosyncratic liquidity shocks, can invest in a liquid storage technology or in a partially illiquid Cobb Douglas technology. By pooling liquidity risk, banks play a growth enhancing role in reducing inefficient liquidation of long term projects, but they may face liquidity crises associated with severe output losses. We show that middle income economies may find optimal to be exposed to liquidity crises, while poor and rich economies have more incentives to develop a fully covered banking system. Therefore, middle income economies could experience banking crises in the process of their development and, as they get richer, they eventually converge to a financially safe long run steady state. Finally, the model replicates the empirical fact of higher costs of banking crises for middle income economies.

Keywords: OLG growth models, liquidity, financial intermediation, financial fragility, banking crises

JEL Classification: E44, G21, O11

Suggested Citation

Gaytan, Alejandro and Rancière, Romain G., Banks, Liquidity Crises and Economic Growth (August 2001). Available at SSRN: https://ssrn.com/abstract=861004 or http://dx.doi.org/10.2139/ssrn.861004

Alejandro Gaytan (Contact Author)

Banco de Mexico, Macrofinancial Analysis Division ( email )

5 de mayo 18, 5th floor,
Col. Centro
Mexico City, 06059 D.F. 06059
Mexico
(5255) 5237 2611 (Phone)
(5255) 5237 2687 (Fax)

Romain G. Rancière

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
262
Abstract Views
2,184
rank
121,271
PlumX Metrics