Flight to liquidity and the Great Recession

Arbeitspapier

This paper argues that counter-cyclical liquidity hoarding by financial intermediaries may strongly amplify business cycles. It develops a dynamic stochastic general equilibrium model in which banks operate subject to agency problems and funding liquidity risk in their inter- mediation activity. Importantly, the amount of liquidity reserves held in the financial sector is determined endogenously: Balance sheet constraints force banks to trade off insurance against funding outflows with loan scale. A financial crisis, simulated as an abrupt decline in the collateral value of bank assets, triggers a flight to liquidity, which strongly amplifies the initial shock and induces credit crunch dynamics sharing key features with the Great Recession. The paper thus develops a new balance sheet channel of shock transmission that works through the composition of banks' asset portfolios.

Object Details

• ISBN: 978-92-899-1137-5
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 1729

Classification and Topics

• Classification: Wirtschaft ; Investment; Capital; Intangible Capital; Capacity ; Business Fluctuations; Cycles ; Financial Markets and the Macroeconomy
• Subject: bank capital channel ; credit crunch ; funding liquidity risk ; liquidity hoarding ; macro-finance

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Radde, Sören
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2014

Further information

• Handle: http://hdl.handle.net/10419/154162
• Last update: 10.03.2025, 11:43 AM CET