Working Paper: NBER ID: w15652
Authors: Andrei Shleifer; Robert W. Vishny
Abstract: In a January 2009 lecture on the financial crisis, Federal Reserve Chairman Bernanke advocated a new Fed policy of credit easing, defined as a combination of lending to financial institutions, providing liquidity directly to key credit markets, and buying of long term securities. We show that Bernanke's analysis and recommendations can be naturally considered in a model of "unstable banking," which relies on two mechanisms: 1) fire sales reduce asset prices below fundamental values, and 2) financial institutions prefer speculation to new lending when markets are dislocated. We analyze credit easing and compare it to alternative government interventions during the crisis.
Keywords: credit easing; fire sales; financial crisis; banking; government intervention
JEL Codes: E51; E58; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fire sales (G33) | reduction in asset prices (G19) |
| reduction in asset prices (G19) | negative feedback loop exacerbating financial instability (F65) |
| liquidation of assets (G33) | drives prices down (D41) |
| banks' equity (G21) | forced more liquidations (G33) |
| market dislocation (G10) | banks prefer speculation over new lending (G21) |
| speculation on existing securities (G10) | crowding-out effect on new lending (E51) |
| government interventions (H53) | raise asset prices (G19) |
| raise asset prices (G19) | mitigate adverse effects of fire sales (G33) |
| mitigate adverse effects of fire sales (G33) | enable banks to resume lending (G21) |