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A Mechanism Design Approach to Financial Frictions

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Abstract

In a thought-provoking article ‘Can a “Credit Crunch” Be Efficient?’ Edward Green and Soo Nam Oh use a mechanism design approach to present a model of financial intermediation in which phenomena qualitatively resembling a ‘credit crunch’ occur but are efficient. In this short chapter, we extend and modify the model of Green and Oh in order to examine how different environments of private information and limited commitment generate different financial frictions. Following a tradition of mechanism design, which considers the market structure as an equilibrium outcome of the underlying environment, we ask questions such as: Which markets are open? Which contracts are used? Which institutions arise? We find that the model of Green and Oh is a useful benchmark to explain the recent literature on the mechanism design approach to financial frictions.

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This paper was originally prepared for the International Economic Association 2011 World Congress held on 4–8 July 2011 in Beijing. I would like to thank Benjamin Moll and Francesco Nava for thoughtful comments.

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Kiyotaki, N. (2012). A Mechanism Design Approach to Financial Frictions. In: Allen, F., Aoki, M., Fitoussi, JP., Kiyotaki, N., Gordon, R., Stiglitz, J.E. (eds) The Global Macro Economy and Finance. International Economic Association Series. Palgrave Macmillan, London. https://doi.org/10.1057/9781137034250_10

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