Modeling the Legend, or, the Trouble with Diamond and Dybvig: Part I

George SelginHas any theoretical work on banking been more influential than Douglas Diamond and Phillip Dybvig ' s1983 JPE article," Bank Runs, Deposit Insurance, and Liquidity " ? If so, I can ' t think of it. With well over 12,000 Google citations and counting, it ' s certainly among the most cited academic papers in economics, let alone in the sub-discipline of monetary economics.Nor has that paper ' s influence been merely academic. Far from it: it is routinely cited by policymakers as supplying a rationale for government intervention in banking, and for explicit national deposit insurance schemes in particular. That the number of countries that adopted such schemes more than quadrupled during the two decades immediately following the article ' s appearance —from just 20 to 87—almost certainly owes something to Diamond and Dybvig ' s influential publication, which is bound to have informed the thinking of experts at the IMF and other international agencies who recommended deposit insurance as the best cure for banking crises.[1] Alas for Diamond and Dybvig and the citizens of the countries that followed those experts ' advice, its practical resultscan ' t be said to have been universally benign.That the Diamond-Dybvig model should have become so popular in policy circles isn ' t hard to fathom. So far as many policymakers (and more than a few economists) are concerned, it shows, " rigorously, " that ordinary (that is, fractional-reserve) banking systems are inherently...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs