Financial Crises and Assets as Media of Exchange

We construct a monetary model of financial crises that can explain two characteristic features of the global financial crisis in 2008/2009, namely, the widespread freeze of asset transactions and a sharp contraction in aggregate output. We assume that the assets, such as real estate, work as media of exchange on a de facto basis in the goods market. In the financial crisis, excessively indebted investors hoard the assets hoping for a miraculous rise in their value (risk-shifting behavior), although the asset hoarding hinders the assets from working as media of exchange in the goods trading. Accordingly, the asset hoarding causes the disappearance of a significant portion of broad "money," which directly results in a contraction in aggregate production. Since the root of the problem is an external diseconomy caused by excessive indebtedness of investors, fiscal and monetary policies and debt reduction for investors have almost equivalent effects in terms of recovery efforts in a financial crisis.