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Banking, Liquidity and Bank Runs in an Infinite Horizon Economy

We develop a variation of the macroeconomic model of banking in Gertler and Kiyotaki (GK2011) that allows for household liquidityrisks and bank runs as in Diamond and Dybvig (DD1983). As in GK, endogenous procyclical movements in bank balance sheets lead to countercyclical fluctuations in the cost of bank credit. However, due to maturity mismatch in banking, bank runs are possible as in DD. Whether a bank run equilibrium exists depends on the condition of bank balance sheets and an endogenously determined liquidation price for bank assets. Thus in normal times a bank run equilibrium may not exist, but the possibility can arise in a severe recession. Overall, the goal is to present a framework that synthesizes the macroeconomic and microeconomic approaches to banking and banking instability.

Authors: 
Mark Gertler, New York University
Nobuhiro Kiyotaki, Princeton University
Publication Date: 
May, 2012
Publication Status: