OPTIMAL FINANCIAL CRISES

Empirical evidence suggests that banking panics are related to the bus iness cycle and are not simply the result of ''sunspots.'' Panics occu r when depositors perceive that the returns on bank assets are going t o be unusually low. We develop a simple model of this. In this setting , bank runs can be first-best efficient: they allow efficient risk sha ring between early and late withdrawing depositors and they allow bank s to hold efficient portfolios. However, if costly runs or markets for risky assets are introduced, central bank intervention of the right k ind can lead to a Pareto improvement in welfare.