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Money, financial stability and efficiency

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  • Allen, Franklin
  • Carletti, Elena
  • Gale, Douglas

Abstract

Most analyses of banking crises assume that banks use real contracts but in practice contracts are nominal. We consider a standard banking model with aggregate return risk, aggregate liquidity risk and idiosyncratic liquidity shocks. With non-contingent nominal deposit contracts, a decentralized banking system can achieve the first-best efficient allocation if the central bank accommodates the demands of the private sector for fiat money. Price level variations allow full sharing of aggregate risks. An interbank market allows the sharing of idiosyncratic liquidity risk. In contrast, idiosyncratic (bank-specific) return risks cannot be shared using monetary policy alone as real transfers are needed.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 149 (2014)
Issue (Month): C ()
Pages: 100-127

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Handle: RePEc:eee:jetheo:v:149:y:2014:i:c:p:100-127

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Web page: http://www.elsevier.com/locate/inca/622869

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Keywords: Central bank; Commercial banks; Risk sharing;

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References

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  2. Gaetano Antinolfi & Elisabeth Huybens, 2000. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Econometric Society World Congress 2000 Contributed Papers 1156, Econometric Society.
  3. Xavier Freixas & Antoine Martin & David Skeie, 2011. "Bank Liquidity, Interbank Markets, and Monetary Policy," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 24(8), pages 2656-2692.
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  6. Champ, B. & Smith, B.D., 1991. "Currency Elasticity and Banking Panics: theory and Evidence," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9109, University of Western Ontario, The Centre for the Study of International Economic Relations.
  7. Douglas W. Diamond & Raghuram G. Rajan, 2001. "Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 109(2), pages 287-327, April.
  8. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(3), pages 401-19, June.
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  13. Cao, Jin & Illing, Gerhard, 2011. "Endogenous exposure to systemic liquidity risk," Munich Reprints in Economics, University of Munich, Department of Economics 19998, University of Munich, Department of Economics.
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  15. Chari, V V & Jagannathan, Ravi, 1988. " Banking Panics, Information, and Rational Expectations Equilibrium," Journal of Finance, American Finance Association, American Finance Association, vol. 43(3), pages 749-61, July.
  16. Franklin Allen & Elena Carletti & Douglas Gale, 2009. "Interbank Market Liquidity and Central Bank Intervention," Economics Working Papers, European University Institute ECO2009/09, European University Institute.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Money, Financial Stability and Efficiency
    by Christian Zimmermann in NEP-DGE blog on 2011-04-02 17:06:00
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Cited by:
  1. Allen, Franklin & Vayanos, Dimitri & Vives, Xavier, 2014. "Introduction to financial economics," Journal of Economic Theory, Elsevier, Elsevier, vol. 149(C), pages 1-14.

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