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Liquidity and the Allocation of Credit: Business Cycle, Government Debt and Financial Arrangements

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Author Info
Filippo Taddei

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Abstract

I analyze the equilibrium level of liquidity and its relevance for the allocation of credit, when the notion of liquidity is related to private information. The general equilibrium analysis yields the following main implications: firstly, it provides an explanation of procyclical liquidity even in the presence of security endogeneity; secondly, it illustrates how government debt, by providing liquidity to an otherwise illiquid private market, encourages rather than “crowds out” private investment; thirdly, it offers a well defined notion of securities’ value, the liquidity of which is endogenously enhanced by the arrangements within financial markets. The approach jointly analyzes the three factors crucial to liquidity: (1) its level is endogenously determined through equilibrium pricing while entrepreneurs choose which security to issue; (2) the introduction of government debt has the two-fold effect of directly providing liquidity to entrepreneurs and indirectly influencing the type of securities they issue in equilibrium; (3) financial markets develop arrangements to allow the beneficial employment of securities, not only physical assets, as collateral (financial pyramiding).

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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 65.

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Length: 64 pages
Date of creation: 2007
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Handle: RePEc:cca:wpaper:65

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Related research
Keywords: Liquidity; Collateral; Business Cycle; Government Debt; Financial Arrangements; Tranching; Financial Pyramiding.;

Find related papers by JEL classification:
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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  1. Ricardo J. Caballero & Arvind Krishnamurthy, 2002. "A Dual Liquidity Model for Emerging Markets," American Economic Review, American Economic Association, vol. 92(2), pages 33-37, May. [Downloadable!]
    Other versions:
  2. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February. [Downloadable!] (restricted)
    Other versions:
  3. Andrea L. Eisfeldt, 2004. "Endogenous Liquidity in Asset Markets," Journal of Finance, American Finance Association, vol. 59(1), pages 1-30, 02. [Downloadable!] (restricted)
  4. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467. [Downloadable!] (restricted)
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    Other versions:
  6. Nobuhiro Kiyotaki & John Moore, 2002. "Balance-Sheet Contagion," American Economic Review, American Economic Association, vol. 92(2), pages 46-50, May. [Downloadable!]
  7. Krishnamurthy, Arvind, 2003. "Collateral constraints and the amplification mechanism," Journal of Economic Theory, Elsevier, vol. 111(2), pages 277-292, August. [Downloadable!] (restricted)
  8. Nobuhiro Kiyotaki & John Moore, 2004. "Liquidity, Bussiness Cycles and Monetary Policy," ESE Discussion Papers 113, Edinburgh School of Economics, University of Edinburgh.
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    Other versions:
  10. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
    Other versions:
  11. Holmstrom, Bengt & Tirole, Jean, 1996. "Modeling Aggregate Liquidity," American Economic Review, American Economic Association, vol. 86(2), pages 187-91, May. [Downloadable!] (restricted)
  12. Huang, Ming, 2003. "Liquidity shocks and equilibrium liquidity premia," Journal of Economic Theory, Elsevier, vol. 109(1), pages 104-129, March. [Downloadable!] (restricted)
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  15. Edmond S. Phelps, 1964. "Second Essay on the Golden Rule of Accumulation," Cowles Foundation Discussion Papers 173, Cowles Foundation, Yale University. [Downloadable!]
  16. Vincent Reinhart & Brian Sack, 2000. "The Economic Consequences of Disappearing Government Debt," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2000-2), pages 163-220. [Downloadable!]
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    Other versions:
  20. Douglas W. Diamond & Raghuram G. Rajan, 2002. "Bank Bailouts and Aggregate Liquidity," American Economic Review, American Economic Association, vol. 92(2), pages 38-41, May. [Downloadable!]
  21. Eisfeldt, Andrea L. & Rampini, Adriano A., 2006. "Capital reallocation and liquidity," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 369-399, April. [Downloadable!] (restricted)
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  23. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Simone Cerreia-Vioglio & Fabio Maccheroni & Massimo Marinacci & Luigi Montrucchio, 2008. "Complete Monotone Quasiconcave Duality," Carlo Alberto Notebooks 80, Collegio Carlo Alberto. [Downloadable!]
  2. Russell Gerrard & Bjarne Højgaard & Elena Vigna, 2008. "Choosing the Optimal Annuitization Time Post Retirement," Carlo Alberto Notebooks 76, Collegio Carlo Alberto. [Downloadable!]
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