It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of this liquidation cost, the recession associated with a banking panic is protracted. For intermediate values, the recession is more severe but short lived. For relatively large values, the contemporaneous decline in real output in the event of a panic is substantial but followed by a vigorous rebound in real activity above the long-run level. I argue that these theoretical predictions are consistent with the observed disparity in crisis-related output losses.
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Working Paper
Banking Panics and Protracted Recessions
October 2015
WP 15-39 — This paper develops a dynamic model of bank liquidity provision to characterize the ex post efficient policy response to a banking panic and study its implications for the behavior of output in the aftermath of a panic.
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