Financial crises occur out of prolonged and credit-fueled boom periods and, at times, they are initiated by relatively small shocks that can have large effects. Consistent with these empirical observations, this paper extends a standard macroeconomic model to include financial intermediation, long-term loans, and occasional financial crises. Within this framework, intermediaries raise their lending and leverage in good times, thereby building up financial fragility. Crises typically occur at the end of a prolonged boom, initiated by a moderate adverse shock that triggers a liquidation of existing investment, a contraction in lending, and ultimately a deep and persistent recession.
Paul, Pascal. 2017. “A Macroeconomic Model with Occasional Financial Crises,” Federal Reserve Bank of San Francisco Working Paper 2017-22. Available at https://doi.org/10.24148/wp2017-22