DP8525 Inefficient Provision of Liquidity

Author(s): Oliver Hart, Luigi Zingales
Publication Date: August 2011
Keyword(s): banking, liquidity, money
JEL(s): E41, E51, G21
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8525

We study an economy where the lack of a simultaneous double coincidence of wants creates the need for a relatively safe asset (money). We show that, even in the absence of asymmetric information or an agency problem, the private provision of liquidity is inefficient. The reason is that liquidity affects prices and the welfare of others, and creators do not internalize this. This distortion is present even if we introduce lending and government money. To eliminate the inefficiency the government must restrict the creation of liquidity by the private sector.