Anatomy of a Financial Crisis / Frederic S. Mishkin.

By:

Mishkin, Frederic S

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w3934.Publication details: Cambridge, Mass. National Bureau of Economic Research 1991.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: This paper provides an asymmetric information framework for understanding the nature of financial crises. It provides the following precise definition of a financial crisis: A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities. As a result, a financial crisis can drive the economy away from an equilibrium with high output in which financial markets perform well to one in which output declines sharply. The asymmetric information framework explains the patterns in the data and many features of these crises which are otherwise hard to explain. It indicates that financial crises have effects over and above those resulting from bank panics and therefore provides a rationale for an expanded lender-of-last resort role for the central bank in which the central bank uses the discount window to provide liquidity to sectors outside of the banking system.

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Previous	nber w3931 How Long do Unilateral Target Zones Last? /	nber w3932 Consumption Taxes in a Life-Cycle Framework: Are Sin Taxes Regressive? /	nber w3933 Local House Price Indexes: 1982-1991 /	nber w3934 Anatomy of a Financial Crisis /	nber w3935 Errors in Output Deflators Revisited: Unit Values and the PPI /	nber w3936 Openness and Inflation: Theory and Evidence /	nber w3937 Revisions and Investment Plans and the Stock Market Rate of Return /	Next

December 1991.

This paper provides an asymmetric information framework for understanding the nature of financial crises. It provides the following precise definition of a financial crisis: A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities. As a result, a financial crisis can drive the economy away from an equilibrium with high output in which financial markets perform well to one in which output declines sharply. The asymmetric information framework explains the patterns in the data and many features of these crises which are otherwise hard to explain. It indicates that financial crises have effects over and above those resulting from bank panics and therefore provides a rationale for an expanded lender-of-last resort role for the central bank in which the central bank uses the discount window to provide liquidity to sectors outside of the banking system.