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The welfare benefits of stable and efficient payment systems

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  • Stephen Millard
  • Matthew Willison

Abstract

The Bank of England's second core purpose is to maintain the stability of the financial system. Payment systems, by supporting transactions, are a key aspect of this. In this paper, we examine the importance of smoothly functioning payment systems to the economy by extending a recently developed theoretical model of banks. In the model the risk of theft implies a cost to using cash. This risk can be avoided by depositing cash in banks and transferring money through an interbank payment system. However, agents are then exposed to the risk that the payment system is unreliable. Agents will use a payment system (rather than cash) to make transactions if the system is sufficiently cheap to use and/or it is sufficiently reliable. We show that the introduction of a payment system that buyers and producers choose to use unambiguously increases social welfare if it expands the number of trades occurring in the economy. This is more likely the more reliable is the payment system. When the introduction of a payment system does not increase the number of trades, social welfare may increase or decrease depending on the trade-off between the risk of using cash and the risk that the payment system is unreliable. We again show that the more reliable is the payment system, the more likely welfare is increased by its introduction and we illustrate how this benefit might be quantified.

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Paper provided by Bank of England in its series Bank of England working papers with number 301.

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Date of creation: Jul 2006
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Handle: RePEc:boe:boeewp:301

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  1. Giovanni Immordino & Marco Pagano, 2003. "Legal Standards, Enforcement and Corruption," CSEF Working Papers 98, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Oct 2009.
  2. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  3. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  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.
  5. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.
  6. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
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Cited by:
  1. Massimo Cirasino & Mario Guadamillas & José Antonio García & Fernando Montes-Negret, 2007. "Reforming Payments and Securities Settlement Systems in Latin America and the Caribbean," World Bank Publications, The World Bank, number 6630, October.

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