New study reveals banks may be inherently unstable, impacting global economy.
The Diamond and Dybvig model is a key advancement in studying banking systems. It uses mechanism-design theory to explore how banks work, focusing on issues like financial fragility and banker incentives. The model helps us understand how banks handle payments and manage risks. Recent economic crises have shown that banks can be unstable, leading to central banks taking action to prevent financial meltdowns. The model highlights the importance of information and transaction timing in providing insurance against unexpected events. It also sheds light on how money and credit are affected by expectations about the future.