Essays on Financial Stability

Abstract

This thesis examines self-fulfilling liquidity crises that are associated with maturity and liquidity transformation conducted by financial intermediaries such as banks. It consists of three chapters. In the first chapter, we argue that the government can eliminate financial fragility by issuing government debt, which is then used to manage liquidity needs. We argue that government debt is particularly suited to manage liquidity needs as it is less likely to be subject to self-fulfilling runs than private debt. In the second chapter, we show that if a single government's fiscal power is limited, government debt may become subject to runs. In this case, supranational agreements can help to mitigate this limitation and resolve contagious and self-fulfilling sovereign debt and banking crises. In the third chapter, we argue that financial fragility may arise when agents circumvent regulatory requirements and conduct shadow banking. In particular, we argue that self-fulfilling panics in the shadow banking sector can be contagious and affect other parts of the financial system via pecuniary channels.