Puzzling over the Anatomy of Crises: Liquidity and the Veil of Finance

No 13-E-09, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: The paper claims that conventional monetary theory obliterates the central role played by media of exchange in the workings and instability of capitalist economies; and that a significant part of the financial system depends on the resiliency of paper currency and liquid assets that have been built on top of it. The resilience of the resulting financial tree is questionable if regulators are not there to adequately trim its branches to keep it from toppling by its own weight or minor wind gusts. The issues raised in the paper are not entirely new but have been ignored in conventional theory. This is very strange because disregard for these key issues has lasted for more than half a century. Are we destined to keep on making the same mistake? The paper argues that a way to prevent that is to understand its roots, and traces them to the Keynes/Hicks tradition. In addition, the paper presents a narrative and some empirical evidence suggesting a key channel from Liquidity Crunch to Sudden Stop, which supports the view that liquidity/credit shocks have been a central factor in recent crises. In addition, the paper claims that liquidity considerations help to explain (a) why a credit boom may precede financial crisis, (b) why capital inflows grow in the run-up of balance-of-payments crises, and (c) why gross flows are pro-cyclical.

Keywords: Financial Crises; Bubbles; Sudden Stop (search for similar items in EconPapers)
JEL-codes: E32 E65 F32 (search for similar items in EconPapers)
Date: 2013-09
New Economics Papers: this item is included in nep-cba, nep-his, nep-hpe, nep-ifn, nep-mac, nep-mon and nep-pke
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (30)

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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:13-e-09

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