DP12116 Sources of Liquidity and Liquidity Shortages

Author(s): Charles M. Kahn, Wolf Wagner
Publication Date: June 2017
Keyword(s): liquidity regulation, liquidity sources, public liquidity
JEL(s): G21, G28
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12116

We investigate a model of liquidity sources that incorporates a general equilibrium feature of liquidity: when banks hold more liquidity, other sectors of the economy hold less of it and will consequently supply less in times of crisis. The private allocation of liquidity is inefficient and optimal liquidity regulation depends on the source of liquidity to which it is applied. Our model also identifies a limited role for public provision of liquidity, arising only when there is a general liquidity shortage in the economy but not if the shortage materializes solely in the banking system.