Banks, Liquidity Crises and Economic Growth

Alejandro Gaytan and Romain Ranciere

DEGIT Conference Papers from DEGIT, Dynamics, Economic Growth, and International Trade

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 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. 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, eventually converge to a financially safe long run steady state. The model also replicates the empirical fact of higher costs of banking crises for middle income economies. Finally, using GMM dynamic panel data techniques for a sample of 83 countries we show that growth implications of the model are consistent with the empirical facts.

Keywords: OLG growth models; liquidity; financial intermediation; financial fragility; banking crises (search for similar items in EconPapers)
JEL-codes: E44 G21 O11 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2005-06
New Economics Papers: this item is included in nep-ban, nep-dev, nep-dge, nep-fdg and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Banks, Liquidity Crises and Economic Growth (2005)
Working Paper: Banks, Liquidity Crises and Economic Growth (2004)
Working Paper: Banks, liquidity crises and economic growth (2003)
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