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Financial Intermediation, Liquidity, And Inflation

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  • Chiu, Jonathan
  • Meh, Césaire A.

Abstract

This paper develops a search-theoretic model to study the interaction between banking and monetary policy and how this interaction affects the allocation and welfare. Regarding how banking affects the welfare costs of inflation: First, we find that, with banking, inflation generates smaller welfare costs. Second, we show that, lowering inflation improves welfare not just by reducing consumption/production distortions, but also by avoiding intermediation costs. Therefore, understanding the nature of intermediation cost is critical for accurately assessing the welfare gain of lowering the inflation target. Regarding how monetary policy affects the welfare effects of banking: First, banking always improves efficiency of production, but the banking technology has to be efficient to improve welfare (especially in low inflation economy). Second, welfare effects of banking depend on monetary policy. For low inflation, banking is not active. For high inflation, banking is active and improves welfare. For moderate inflation, banking is active but reduces welfare. Owing to general equilibrium feedback, banking is supported in equilibrium even though welfare is higher without banking.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 15 (2011)
Issue (Month): S1 (April)
Pages: 83-118

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Handle: RePEc:cup:macdyn:v:15:y:2011:i:s1:p:83-118_00

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References

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  1. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  2. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  3. David Andolfatto & Ed Nosal, 2003. "A Theory of Money and Banking," Macroeconomics 0310003, EconWPA.
  4. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
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Cited by:
  1. Jonathan Chiu & Mei Dong & Enchuan Shao, 2012. "On the Welfare Effects of Credit Arrangements," Working Papers 12-43, Bank of Canada.
  2. Mariana Rojas Breu, 2013. "The Welfare Effect Of Access To Credit," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 235-247, 01.
  3. Jonathan Chiu & Cesaire Meh & Randall Wright, 2011. "Innovation and growth with financial, and other, frictions," Working Papers 688, Federal Reserve Bank of Minneapolis.

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