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May 29 Workshop: Uncertainty in an Interconnected Financial System, Contagion, and Market Freezes

MAY 30, 2014

 

Presenter: F. Milne, Queen’s University, Department of Economics(Podcast)
Discussant: T. Gravelle, General Director of the Financial Sector Policy Branch of the Government of Canada (Podcast)

This workshop studied contagion and market freezes caused by uncertainty in financial network structures and provides theoretical guidance for central banks. Prof. Frank Milne and his co-authors establish a formal model to demonstrate that, in a financial system where financial institutions are interconnected, a negative shock to an individual financial institution could spread to other institutions, causing market freezes because of creditors’ uncertainty about the financial network structure. Central bank policies to alleviate market freezes and contagion, such as information policy, bailout policy and the lender of last resort policy, have been examined.

Toni Gravelle said that the network model described by F. Milne is very interesting and he actually works on such a model. The market freezes caused by the uncertainty are well modeled and the need of the lender of last resort becomes less important in such a model through central bank communications.