Shadow Bank run: The Story of a Recession

This paper proposes a DSGE model of liquidity mismatch and bank runs, which incorporates housing and credit markets. The paper shows that a real shock is amplified by the financial sector through household balance sheets, bank... [ view full abstract ]

This paper proposes a DSGE model of liquidity mismatch and bank runs, which incorporates housing and credit markets. The paper shows that a real shock is amplified by the financial sector through household balance sheets, bank balance sheets and market liquidity channels. The shock, depending on macroeconomic fundamentals, may shift the economy from a no-bank run to a bank run equilibrium. In the case of bank run equilibrium, households stop rolling over their deposits and banks are forced to liquidate their assets at fire sale prices. This paper shows that introducing the housing and credit markets shortens the sunspots’ lifetime while asset liquidity prices reduce. In addition, this paper comprehensively details the consequences of economic crises, namely the output downward spiral, home price double-dip and lengthy recovery period. Here, it is indicated that macropruential policy tools in the form of capital adequacy buffers and loan-to-value ratios safeguard the economy against extreme busts and help mitigate systemic risks by insulating asset prices.