Booms and Banking Crises

Banking crises are rare events that break out in the midst of credit-intensive booms and bring about deep and long-lasting recessions. This paper presents a textbook dynamic stochastic general equilibrium model to explain these phenomena. The model features a nontrivial banking sector, where bank heterogeneity gives rise to an interbank market. Moral hazard and asymmetric information in this market may lead to sudden market freezes, banking crises, credit crunches, and severe "financial" recessions. Those recessions follow credit booms and are not necessarily triggered by large exogenous adverse shocks.