A Model to Analyse Financial Fragility: Applications.

Charles A.E. Goodhart: Bank of England, London School of Economics, and Financial Markets Group

Pojanart Sunirand: Bank of England and London School of Economics

Dimitrios P. Tsomocos: Bank of England, Said Business School and St. Edmund Hall, University of Oxford, and Financial Markets Group

Abstract

The purpose of our work is to explore contagious financial crises. To this end, we use simplified, thus numerically solvable, versions of our general model [Goodhart, Sunirand and Tsomocos (2003)]. The model incorporates heterogeneous agents, banks and endogenous default, thus allowing various feedback and contagion channels to operate in equilibrium.

Such a model leads to di.erent results from those obtained when using a standard representative agent model. For example, there may be a trade-o. between e.ciency and financial stability, not only for regulatory policies, but also for monetary policy. Moreover, agents which have more investment opportunities can deal with negative shocks more effectively by transferring ‘negative externalities’ onto others.

JEL Classification: D52; E4; E5; G1; G2

Keywords: Financial Fragility; Competitive Banking; General Equilibrium; Monetary Policy; Regulatory Policy

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