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Collateral Restrictions and Liquidity Under-Supply: A Simple Model

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Abstract

We show that very little is needed to create liquidity under-supply in equilibrium. Credit constraints on demand by themselves can cause an under-supply of liquidity, without the uncertainty, intermediation, asymmetric information or complicated international financial framework used in other models in the literature. We show that the under-supply is a non-monotone function of the demand distortion that causes it, a result that may have interesting implications for emerging markets economies. Finally, when we make the credit constraint endogenous, the inefficiency can be large due to the presence of a multiplier.

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File URL: http://cowles.econ.yale.edu/P/cd/d14b/d1468-r.pdf
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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1468R.

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Length: 31 pages
Date of creation: Jun 2004
Date of revision: Aug 2006
Publication status: Published in Economic Theory (2008), 35: 441-467
Handle: RePEc:cwl:cwldpp:1468r

Note: CFP 1236.
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Keywords: Liquidity under-supply; Credit constraint; Non-monotonicity; Multiplier; Collateral equilibrium;

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References

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  1. P. A. Diamond, 1982. "Money in Search Equilibrium," Working papers 297, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  3. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University.
  4. Hyun Song Shin & Stephen Morris, 2004. "Liquidity Black Holes," Econometric Society 2004 North American Winter Meetings 644, Econometric Society.
  5. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  6. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Liquidity Shortages and Banking Crises," NBER Working Papers 10071, National Bureau of Economic Research, Inc.
  7. Martin Shubik, 2000. "The Theory of Money," Cowles Foundation Discussion Papers 1253, Cowles Foundation for Research in Economics, Yale University.
  8. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
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Cited by:
  1. Ana Fostel & John Geanakoplos, 2010. "Why Does Bad News Increase Volatility and Decrease Leverage?," Cowles Foundation Discussion Papers 1762R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2011.
  2. M. Peiris & Alexandros Vardoulakis, 2013. "Savings and default," Economic Theory, Springer, vol. 54(1), pages 153-180, September.
  3. Franklin Allen, 2010. "Comment on "The Leverage Cycle"," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 67-73 National Bureau of Economic Research, Inc.
  4. Guembel, Alexander & Sussman, Oren, 2010. "Liquidity, Contagion and Financial Crisis," TSE Working Papers 10-240, Toulouse School of Economics (TSE).
  5. Weerachart Kilenthong, 2011. "Collateral premia and risk sharing under limited commitment," Economic Theory, Springer, vol. 46(3), pages 475-501, April.
  6. Hanno Lustig, 2011. "Why Does the Treasury Issue TIPS? The TIPS-Treasury Bond Puzzle," 2011 Meeting Papers 1443, Society for Economic Dynamics.
  7. Eric van Wincoop & Cedric Tille & Philippe Bacchetta, 2010. "On the Dynamics of Leverage, Liquidity, and Risk," 2010 Meeting Papers 393, Society for Economic Dynamics.
  8. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
  9. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.

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