Abstract
This study investigates banks’ liquidity provision using the Lagos and Wright model of monetary exchange. With aggregate uncertainty, we show that banks sometimes exhaust their cash reserves and fail to satisfy their depositors’ needs for consumption smoothing. We also show that banking crises can be eliminated by a rate-of-return-equalizing policy under perfect risk sharing, but the first-best outcome can be only achieved with the Friedman rule. These results cannot be obtained with other monetary models (e.g., overlapping generations models). We also derive a rich array of non-trivial effects of inflation on equilibrium deposits, the probability of banking crises, and banks’ portfolios.
Original language | English |
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Article number | 103724 |
Pages (from-to) | 1-22 |
Number of pages | 22 |
Journal | Journal of Economic Dynamics and Control |
Volume | 108 |
DOIs | |
Publication status | Published - 1 Nov 2019 |
Funding
We thank Pedro Gomis-Porqueras, Todd Keister, Randy Wright, and participants at the 2017 Summer Workshop on Money, Payments, Banking and Finance held at the Bank of Canada for useful feedbacks. We also thank for his helpful comments and suggestions. This research was supported by JSPS KAKENHI Grant Number JP17K13703 and a grant-in-aid from Zengin Foundation for Studies on Economics and Finance.
Funders | Funder number |
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Japan Society for the Promotion of Science | 17K13703 |
Zengin Foundation For Studies On Economics And Finance |
Keywords
- Banking crisis
- Liquidity
- Monetary equilibrium
- Money search