Bank Runs and Business Cycles in a Small Open Economy

This paper incorporates financial intermediaries within a small open DSGE model and studies the effects of bank runs on economic activities. Shocks to the world interest rate induce capital outflows and asset price reduction, and the decline in asset prices weakens intermediaries' balance sheets, making them vulnerable to bank runs and leading, in turn, to a more severe and persistent recession. Our model is successful in generating some key properties observed in emerging market business cycles. We also asses the stabilization effect of capital control policy, numerical experiment suggests that countercyclical tax on capital flows is effective in absorbing the disturbance from external financial shocks and reducing the probability of bank runs.