Recession, high interest rates and instability: simple macro-dynamics

We present a highly stylized closed economy macro-model that recreates some empirically verified aspects of financial and macroeconomic instability in emerging markets. Simple dynamics show how a recession may lead to a shortfall of liquidity of banks which in turn may be forced to acquire additional liabilities and increase deposit rates. We show that an unstable path may emerge as a result of high interest rates paid on deposits and low output levels.