Economic Insights — What should policymakers do when depositors flee banks, as they did after Silicon Valley Bank collapsed in 2023? Much depends on how banks create liquidity.
Banks play an important role in liquidity creation. Yet there is no consensus on the exact mechanism by which liquidity is created through the banking system. This has policy implications when there are large deposit outflows from the banking system, as in the aftermath of SVB's failure. This article illustrates two potential mechanisms and presents recent empirical evidence. So far, there is no consensus in the literature on how lending was impacted by SVB's failure. It's likely that both mechanisms are at work in the real world.
This article appeared in the First Quarter 2025 issue of Economic Insights. Download and read the full issue.
