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Inefficient liquidity provision

Author

Listed:
  • John Geanakoplos

    (Yale University
    Santa Fe Institute)

  • Kieran James Walsh

    (University of Virginia Darden School of Business)

Abstract

We prove that in competitive market economies with no insurance for idiosyncratic risks, agents will always overinvest in illiquid long-term assets and underinvest in short-term liquid assets. We take as our setting the seminal model of Diamond and Dybvig (J Polit Econ 91(3):401–419, 1983), who first posed the question in a tractable model. We reach such a simple conclusion under mild conditions because we stick to the basic competitive market framework, avoiding the banks and intermediaries that Diamond and Dybvig (1983) and others introduced.

Suggested Citation

  • John Geanakoplos & Kieran James Walsh, 2018. "Inefficient liquidity provision," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(1), pages 213-233, July.
    • Handle: RePEc:spr:joecth:v:66:y:2018:i:1:d:10.1007_s00199-017-1059-7
    DOI: 10.1007/s00199-017-1059-7
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    References listed on IDEAS

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    1. Anil K. Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2014. "How does macroprudential regulation change bank credit supply?," NBER Working Papers 20165, National Bureau of Economic Research, Inc.
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    4. John Geanakoplos & Kieran Walsh, 2016. "Uniqueness and Stability of Equilibrium in Economies with Two Goods," Cowles Foundation Discussion Papers 2050, Cowles Foundation for Research in Economics, Yale University.
    5. Borys Grochulski & Yuzhe Zhang, 2015. "Optimal Liquidity Regulation With Shadow Banking," Working Paper 15-12, Federal Reserve Bank of Richmond.
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    9. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, July.
    10. Ana Fostel & John Geanakoplos, 2008. "Collateral restrictions and liquidity under-supply: a simple model," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 35(3), pages 441-467, June.
    11. Villamil, A P, 1991. "Demand Deposit Contracts, Suspension of Convertibility, and Optimal Financial Intermediation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 1(3), pages 277-288, July.
    12. Pierre Yared, 2013. "Public Debt Under Limited Private Credit," Journal of the European Economic Association, European Economic Association, vol. 11(2), pages 229-245, April.
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    Cited by:

    1. Borys Grochulski & Yuzhe Zhang, 2019. "Optimal liquidity policy with shadow banking," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 68(4), pages 967-1015, November.
    2. Toda, Alexis Akira, 2019. "Wealth distribution with random discount factors," Journal of Monetary Economics, Elsevier, vol. 104(C), pages 101-113.
    3. Thomas M. Eisenbach & Gregory Phelan, 2022. "Cournot Fire Sales," American Economic Journal: Macroeconomics, American Economic Association, vol. 14(3), pages 508-542, July.
    4. Zannini, Ugo, 2020. "The optimal quantity of money and partially-liquid assets," Journal of Economic Theory, Elsevier, vol. 188(C).

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    More about this item

    Keywords

    Liquidity; Constrained inefficiency; Diamond–Dybvig models; Fire sales;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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