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Liquidity, Money Creation And Destruction, And The Returns To Banking

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  • Ricardo de O. Cavalcanti
  • Andrés Erosa
  • Ted Temzelides

Abstract

We build on our earlier model of money in which bank liabilities circulate as a medium of exchange. We investigate optimal bank behavior and the resulting provision of liquidity under a range of central bank regulations. In our model, banks issue inside money under fractional reserves, facing the possibility of excess redemptions. Banks consider the float resulting from money creation and make reserve-management decisions that affect aggregate liquidity conditions. Numerical examples demonstrate positive bank failure rates when returns to banking are low. Central bank interventions may improve banks' returns and welfare through a reduction in bank failure. Copyright 2005 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

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Bibliographic Info

Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 46 (2005)
Issue (Month): 2 (05)
Pages: 675-706

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Handle: RePEc:ier:iecrev:v:46:y:2005:i:2:p:675-706

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References

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  1. Ricardo Cavalcanti & Andres Erosa & Ted Temzelides, 1997. "Private money and reserve management in a random matching model," Working Papers 97-24, Federal Reserve Bank of Philadelphia.
  2. Cavalcanti, Ricardo de Oliveira & Forno, Henrique Dezemone, 2004. "Cyclical Interest Payments on Inside Money," Economics Working Papers (Ensaios Economicos da EPGE) 546, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  3. David C. Mills, Jr., 2006. "A model in which outside and inside money are essential," Finance and Economics Discussion Series 2006-38, Board of Governors of the Federal Reserve System (U.S.).
  4. Ricardo O. Cavalcanti, 2004. "A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright," Economic Theory, Springer, vol. 24(4), pages 769-788, November.
  5. Cavalcanti, Ricardo de Oliveira, 2003. "A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright," Economics Working Papers (Ensaios Economicos da EPGE) 476, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  6. Fischer, Stanley, 1986. "Friedman versus hayek on private money: Review essay," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 433-439, May.
  7. Hanson, John R, II, 1979. "Money in the Colonial American Economy: An Extension," Economic Inquiry, Western Economic Association International, vol. 17(2), pages 281-86, April.
  8. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "A model of private bank-note issue," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 104-136, January.
  9. Chang, Roberto, 1999. "Comment on Private Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 492-98, August.
  10. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  11. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
  12. Cavalcanti, Ricardo de Oliveira & Forno, Henrique Dezemone, 2004. "Money with Bank Networks," Economics Working Papers (Ensaios Economicos da EPGE) 545, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  13. King, Robert G., 1983. "On the economics of private money," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 127-158.
  14. 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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Citations

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Cited by:
  1. Allen Head & Junfeng Qiu, 2011. "Elastic Money, Inflation, and Interest Rate Policy," Working Papers 1152, Queen's University, Department of Economics.
  2. Chen, Siyan & Wang, Yougui & Li, Keqiang & Wu, Jinshan, 2014. "Money creation process in a random redistribution model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 394(C), pages 217-225.
  3. Daniel Sanches, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia, revised 04 Feb 2013.
  4. Daniel R. Sanches, 2013. "Banking crises and the role of bank coalitions," Working Papers 13-28, Federal Reserve Bank of Philadelphia, revised 04 Feb 2014.
  5. Ricardo de O. Calacanti, 2010. "Inside-money theory after Diamond and Dybvig," Economic Quarterly, Federal Reserve Bank of Richmond, issue 1Q, pages 59-82.
  6. Andolfatto, David, 2008. "Money, Intermediation, and Banking," MPRA Paper 7321, University Library of Munich, Germany.
  7. Ted Temzelides & Cyril Monnet & Thor Koeppl, 2007. "Mechanism design and Payments," 2007 Meeting Papers 23, Society for Economic Dynamics.
  8. Randall Wright & Lixin Huang & Ping He, 2008. "Money, Banking, and Monetary Policy," 2008 Meeting Papers 347, Society for Economic Dynamics.

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