Banking crises and liquidity in a monetary economy

Tarishi Matsuoka*, Makoto Watanabe

*Corresponding author for this work

Research output: Contribution to JournalArticleAcademicpeer-review

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 languageEnglish
Article number103724
Pages (from-to)1-22
Number of pages22
JournalJournal of Economic Dynamics and Control
Volume108
Early online date11 Sep 2019
DOIs
Publication statusPublished - 1 Nov 2019

Keywords

  • Banking crisis
  • Liquidity
  • Monetary equilibrium
  • Money search

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