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Vol. 64, No. 2, pp. 160-174 (2013)

“Diamond-Rajan Bank Runs in a Production Economy”
Keiichiro Kobayashi (Institute of Economic Research, Hitotsubashi University)

To analyze the macroeconomic consequences of a systemic bank run, we integrate the banking model à la Diamond and Rajan (2001a) into a simplified version of an infinite-horizon neoclassical growth model. The banking sector intermediates collateral-secured loans from households to entrepreneurs. Entrepreneurs also deposit their working capital in banks. A systemic bank run, which is a sunspot phenomenon in this model, results in a deep recession by causing a sudden shortage in working capital. We show that an increase in the probability of a systemic run can persistently lower output, consumption, labor, capital and asset prices, even if a systemic run does not actually occur. This implies that the slowdown in economic growth after a financial crisis may be caused by the increased fragility of the banking system or increased fears of the recurrence of a systemic run.