A Bad-Asset Theory Of Financial Crises
The authors propose a simple model of financial crises, which may be useful for the unified analysis of macro and financial policies implemented during the 2008-2009 financial crisis. A financial crisis is modeled as the disappearance of inside money due to the lemon problem ? la Akerlof (1970), in a simplistic variant of Lucas and Stokey's (1987) Cash-in-Advance economy, where both cash and capital stocks work as media of exchange. The exogenous emergence of a huge amount of bad assets represents the occurrence of a financial crisis. Information asymmetry regarding the good assets (capital stocks) and the bad assets causes the good assets to cease functioning as inside money.