DP11242 Private Money Creation and Equilibrium Liquidity
|Author(s):||Pierpaolo Benigno, Roberto Robatto|
|Publication Date:||April 2016|
|Date Revised:||April 2017|
|Programme Areas:||Financial Economics, Monetary Economics and Fluctuations|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=11242|
We study the joint supply of public and private liquidity using a simple macroeconomic model. In a frictionless, competitive financial market, private intermediaries create riskless securities (safe assets) and the economy achieves the first best. If instead equity is more costly than debt, a pecuniary externality arises, financial intermediaries supply risky securities, and the economy is vulnerable to liquidity crunches. We use our framework to revisit, in the context of the modern financial system, some classic proposals on liquidity supply (real-bills doctrine, free banking, and narrow banking), comparing them with recent interventions (capital requirements and bailouts).