Banking, Liquidity and Bank Runs in an Infinite Horizon Economy

By Mark Gerlter and Nobuhiro Kiyotaki

We develop a variation of the macroeconomic model of banking in Gertler and Kiyotaki (2011) that allows for household liquidity risks and bank runs as in Diamond and Dybvig (1983). As in Gertler and Kiyotaki, because bank net worth fluctuates with aggregate production, the spread in the expected rates of return on bank asset and deposit fluctuates countercyclically. However, because bank assets have a longer maturity than deposits, bank runs are possible as in Diamond and Dybvig. Whether a bank run equilibrium exists depends on bank balance sheets and a liquidation price for bank assets in equilibrium. While in normal times a bank run equilibrium may not exist, the possibility can arise in a recession. Overall, the goal is to present a framework that synthesizes the macroeconomic and microeconomic approaches to banking and banking instability.

It is notoriously difficult to satisfy both macroeconomists and microeconomists, so wel will see whether Gertler and Kiyotaki will manage to pull that off. The paper is very certainly very interesting for macroeconomists, who have long been on the lookout for an elegant, tractable and credible way to think about banking crises and in particular bank runs in a context where the rest of the economy may independently and interdependently be in some sort of trouble as well. This paper will provide a starting point for many others.

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