Fire sales and the financial accelerator
Cook, David E.
|Source||Journal of monetary economics , v. 59, (4), 2012, MAY, p. 336-351|
|Summary||During financial turmoil, increases in risk lead to higher default, foreclosure, and fire sales. This paper introduces a costly liquidation process for foreclosed collateral and pro-cyclical recovery rates in a dynamic stochastic general equilibrium model of the financial accelerator. Links between endogenous recovery rates, risk premia, and default risk generate a liquidity spiral, magnifying financial accelerator effects. We illustrate how collateral liquidation and monetary policy alter the real impact of financial shocks operating through macro-financial linkages; and the way a government subsidy on collateral liquidity and required liquidity buffers can help dampen the liquidity spiral by shoring up recovery rates. © 2012 Elsevier B.V.|
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