Abstract for: Feedback Mechanisms in the Financial System: A Modern View

There is significant empirical evidence of dynamic feedback effects in financial crises. Evidence shows that financial system has a number of elements with procyclical response to various shocks. Under shocks, these elements can initiate a dynamic sequence from being shock absorbers into shock amplifiers. The purpose of this study is to conduct an integrative review of the feedback mechanisms that have been developed to theoretically explain financial system dynamics. Ability to understand various theoretical feedbacks consistently and comprehensively facilitates policy actions to prevent undesirable amplifications. Accordingly, this paper systematically reviews precedent concepts of amplifications and feedbacks. This study proceeds from definitions, then explains the view of positive and negative feedbacks in the financial system, and proposes a typology for organization of systemic feedbacks identified in theoretical literature. The proposed typology incorporates key aspects of a modern financial system and key intermediary functions of financial institutions: transformation of assets and liabilities, credit, and liquidity. In addition to the traditional delegated monitoring intermediary functions, the feedbacks also include key features of modern financial intermediaries: loan sales and off-balance sheet activities, including commitments, securitizations, and derivatives.