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Inefficient Provision of Liquidity

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  • Hart, Oliver
  • Zingales, Luigi

Abstract

We study an economy where the lack of a simultaneous double coincidence of wants creates the need for a relatively safe asset (money). We show that, even in the absence of asymmetric information or an agency problem, the private provision of liquidity is inefficient. The reason is that liquidity affects prices and the welfare of others, and creators do not internalize this. This distortion is present even if we introduce lending and government money. To eliminate the inefficiency the government must restrict the creation of liquidity by the private sector.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8525.

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Date of creation: Aug 2011
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Handle: RePEc:cpr:ceprdp:8525

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Keywords: banking; liquidity; money;

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  1. Douglas W. Diamond & Raghuram G. Rajan, . "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," CRSP working papers 476, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  2. Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2010. "Financial Innovation and Financial Fragility," Working Papers 2010.114, Fondazione Eni Enrico Mattei.
  3. Oliver Hart & John Moore, 1991. "A Theory of Debt Based on the Inalienability of Human Capital," STICERD - Theoretical Economics Paper Series /1991/233, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  4. Joseph M. Ostroy & Ross M. Starr, 1988. "The Transactions Role of Money," UCLA Economics Working Papers 505, UCLA Department of Economics.
  5. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  6. Holmström, Bengt, 2011. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262015783, December.
  7. Fabrizio Mattesini & Cyril Monnet & Randall Wright, 2009. "Banking: a mechanism design approach," Working Papers 09-26, Federal Reserve Bank of Philadelphia.
  8. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. 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.
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Cited by:
  1. Hart, Oliver & Zingales, Luigi, 2013. "Liquidity and Inefficient Investment," CEPR Discussion Papers 9537, C.E.P.R. Discussion Papers.

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