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Liquidity, money creation and destruction, and the returns to banking

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  • de O. Cavalcanti, Ricardo
  • Erosa, Andrés
  • Temzelides, Ted

Abstract

We build on our earlier model of money in which bank liabilities circulate as medium of exchange, and investigate the provision of liquidity for a range of central-bank regulations dealing with the potential of bank failure. In our model, banks issue inside money under fractional reserves, facing the event of excess redemptions. They monitor the float of their money issue and make reserve-management decisions which affect aggregate liquidity conditions. Numerical examples demonstrate bank failure when returns to banking are low. Central-bank interventions, injecting more funds or making interest payments proportional to holdings of reserves, may improve banks’ returns and society’s welfare, followed by a reduction in bank failure. JEL Classification: E4, E5

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0394.

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Date of creation: Sep 2004
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Handle: RePEc:ecb:ecbwps:20040394

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Keywords: liquidity; private money creation;

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  1. Ricardo de O. Cavalcanti & Andres Erosa & Ted Temzelides, 1999. "Private Money and Reserve Management in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 929-945, October.
  2. Cavalcanti, Ricardo de Oliveira & Forno, Henrique Dezemone, 2004. "Cyclical Interest Payments on Inside Money," Economics Working Papers (Ensaios Economicos da EPGE) 546, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  3. King, Robert G., 1983. "On the economics of private money," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 127-158.
  4. Cavalcanti, Ricardo de O & Wallace, Neil, 1999. "Inside and Outside Money as Alternative Media of Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 443-57, August.
  5. 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.
  6. Cavalcanti, Ricardo de Oliveira & Forno, Henrique Dezemone, 2004. "Money with Bank Networks," Economics Working Papers (Ensaios Economicos da EPGE) 545, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  7. Ricardo O. Cavalcanti, 2004. "A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright," Economic Theory, Springer, vol. 24(4), pages 769-788, November.
  8. David C. Mills, Jr., 2006. "A model in which outside and inside money are essential," Finance and Economics Discussion Series 2006-38, Board of Governors of the Federal Reserve System (U.S.).
  9. Fischer, Stanley, 1986. "Friedman versus hayek on private money: Review essay," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 433-439, May.
  10. 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.
  11. Hanson, John R, II, 1979. "Money in the Colonial American Economy: An Extension," Economic Inquiry, Western Economic Association International, vol. 17(2), pages 281-86, April.
  12. Cavalcanti, Ricardo de Oliveira, 2003. "A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright," Economics Working Papers (Ensaios Economicos da EPGE) 476, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  13. Chang, Roberto, 1999. "Comment on Private Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 492-98, August.
  14. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "A model of private bank-note issue," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 104-136, January.
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Cited by:
  1. Andolfatto, David & Nosal, Ed, 2009. "Money, intermediation, and banking," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 289-294, April.
  2. Ricardo de O. Calacanti, 2010. "Inside-money theory after Diamond and Dybvig," Economic Quarterly, Federal Reserve Bank of Richmond, issue 1Q, pages 59-82.
  3. Randall Wright & Lixin Huang & Ping He, 2008. "Money, Banking, and Monetary Policy," 2008 Meeting Papers 347, Society for Economic Dynamics.
  4. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2005. "Mechanism Design and Payments," 2005 Meeting Papers 11, Society for Economic Dynamics.
  5. Daniel Sanches, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia, revised 04 Feb 2013.
  6. Allen Head & Junfeng Qiu, 2011. "Elastic Money, Inflation, and Interest Rate Policy," Working Papers 1152, Queen's University, Department of Economics.
  7. Daniel R. Sanches, 2013. "Banking crises and the role of bank coalitions," Working Papers 13-28, Federal Reserve Bank of Philadelphia, revised 04 Feb 2014.
  8. Chen, Siyan & Wang, Yougui & Li, Keqiang & Wu, Jinshan, 2014. "Money creation process in a random redistribution model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 394(C), pages 217-225.

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