Abstract
Abstract The authors develop a simple agent-based and stock flow consistent model of a monetary economy. Their model is well suited to explain money creation along the lines of mainstream theory. Additionally it uncovers a potential instability that follows from a maturity mismatch of assets and liabilities. The authors analyze the impact of interbank lending on the stability of the financial sector and find that an interbank market stabilizes the economy during normal times but amplifies systemic instability, contagion and bankruptcy cascades during crises. But even with no interbank market, indirect contagion can lead to bankruptcy cascades. The authors also find that the existence of large banks threatens stability and that regulatory policy should target large banks more strictly than small.
Highlights
Oh! what a tangled web we weave When first we practice to deceive! Walter ScottThe recent crisis has vividly demonstrated that the stability of the banking sector is highly important for the stability of the economy as a whole
Instead we show that it is the creation of money that gives endogenously rise to an interconnected banking sector and systemic risk
The only two different kinds of agents it consists of are households and banks. Behavioral rules of these agents are very simple and closely follow those used in basically every introductory macroeconomics textbook
Summary
Oh! what a tangled web we weave When first we practice to deceive! Walter ScottThe recent crisis has vividly demonstrated that the stability of the banking sector is highly important for the stability of the economy as a whole. The authors build on a system of stochastic differential equations and show the existence of a destabilizing financial accelerator In another related research project Tedeschi et al (2011) developed a three sector ACE model that includes the credit sector and a real sector. In a very recent paper, Krause and Giansante (2012) developed a network based interbanking model and analyze its stability by letting one bank fail exogenously. They find that the network structure plays an important role in producing systemic risk and that the probability of observing a cascade is positively correlated with the size of the initially shocked bank
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