Financial crises are widely argued to be due to herd behavior. Yet recently developed models of herd behavior have been subjected to two critiques which seem to make them inapplicable to financial crises. Herds disappear from these models if two of their unappealing assumptions are modified: if their zero-one investment decisions are made continuous and if their investors are allowed to trade a...

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We find that declining bank credit to the private sector will not necessarily constrain the economic recovery after output has bottomed out following a financial crisis. To obtain this result, we examine data from 39 financial crises, which – as the current one – were preceded by credit booms. In these crises the change in bank credit, either in real terms or relative to GDP, consistently did n...

This paper develops a theory of financial crises that explains why crises should be expected to follow periods of sustained lending booms and high banking profitability. When the behavior of agents is affected by the availability heuristic and there is a long period of sustained banking profitability, all agents—banks as well as those who fund banks and those who regulate them—end up in an “ava...

The financial crisis that surfaced in 2007 has stressed the need to identify the ultimate sources of the incentives that were behind the preceding credit and housing bubbles. To lower the likelihood of future financial collapses, prudent economic policies as well as an adequate regulatory and supervisory framework for financial institutions are required. Monetary policy, in turn, should be dire...

We examine the role of macroeconomic ‡uctuations, asset market liquidity, and network structure in determining contagion and aggregate losses in a …nancial system. Systemic instability is explored in a …nancial network comprising three distinct, but interconnected, sets of agents – domestic banks, international …nancial institutions, and …rms. Calibrating the model to advanced country banking s...

I develop a two market agent-based model to study how global portfolio managers affect global financial crises and stability. The Markowitz model is extended by incorporating several insights from behavioral finance. Simulation results of an agent-based version of the Markowitz model reveal that global financial crises do not occur when global managers are added to the model. However, when risk...

This chapter has two objectives: to produce new arguments for an actual policy issue and thus demonstrate the fruitfulness of a new theory. The theory is a recently proposed generalization of Darwinism termed “evolutionary-developmental economics,” which recognizes individuals to be rational only boundedly and unequally. The issue is old, but actualized by the recent financial crises: By what g...

The adverse effects of financial crises in terms of output losses or output growth below its potential can be treated like losses from catastrophic events which have a low likelihood but a large impact in the event that they occur. We therefore analyze GDP losses in terms of frequency (number of loss events per period) and severity (loss per occurrence). Crises’ frequency, severity, and the ass...

i want to thank first the Kansas city fed for inviting me to this splendid symposium. i have found dr. buiter’s paper long, comprehensive, thought-stimulating and, of course, provocative. it is an interesting read unless you belonged to one of the targeted institutions. in what follows, i will talk more about my own observations mostly on the fed, rather than offer direct comments on the paper,...