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Alternative Central Bank Credit Policies for Liquidity Provision in a Model of Payments

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  • David C. Mills

Abstract

I explore alternative central bank credit policies in a theoretical model where (i) money is necessary as a means of payment, (ii) there is a shortage of liquidity that a central bank addresses through the extension of credit, (iii) money is necessary to repay debts, and (iv) the incentives to default are explicit and contingent on the credit policy designed. Using a mechanism design approach, I compare a credit policy of charging an interest rate on credit (like the Federal Reserve's policy) with that of requiring the posting of collateral (like the European Central Bank's policy). I find that the pricing policy can implement good allocations while the collateral policy cannot whenever collateral bears an opportunity cost

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 155.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:155

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Keywords: Payments systems; central banking; liquidity; collateral;

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References

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  1. Bech, Morten L. & Garratt, Rod, 2003. "The intraday liquidity management game," Journal of Economic Theory, Elsevier, Elsevier, vol. 109(2), pages 198-219, April.
  2. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, Elsevier, vol. 81(2), pages 232-251, August.
  3. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper, Federal Reserve Bank of Richmond 98-04, Federal Reserve Bank of Richmond.
  4. Martin, Antoine, 2004. "Optimal pricing of intraday liquidity," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(2), pages 401-424, March.
  5. Rochet, Jean-Charles & Tirole, Jean, 1996. "Controlling Risk in Payment Systems," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 28(4), pages 832-62, November.
  6. Ruilin Zhou, 2000. "Understanding intraday credit in large-value payment systems," Economic Perspectives, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue Q III, pages 29-44.
  7. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," Working Paper, Federal Reserve Bank of Atlanta 98-21, Federal Reserve Bank of Atlanta.
  8. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, Elsevier, vol. 43(1), pages 197-216, February.
  9. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, American Economic Association, vol. 86(5), pages 1126-38, December.
  10. Kobayakawa, Shuji, 1997. "The Comparative Analysis of Settlement Systems," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1667, C.E.P.R. Discussion Papers.
  11. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, Elsevier, vol. 22(1), pages 1-18, January.
  12. Townsend, Robert M, 1989. "Currency and Credit in a Private Information Economy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(6), pages 1323-44, December.
  13. David C. Mills, Jr, 2004. "Mechanism Design and the Role of Enforcement in Freeman's Model of Payments," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 219-236, january.
  14. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
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Cited by:
  1. Jean-Marc Figuet, 2009. "La mise en place de TARGET2 : un élément de la nouvelle architecture financière de l’économie européenne," Revue d'Économie Financière, Programme National Persée, Programme National Persée, vol. 94(1), pages 329-338.
  2. Antoine Martin & James McAndrews, 2008. "Should there be intraday money markets?," Staff Reports, Federal Reserve Bank of New York 337, Federal Reserve Bank of New York.
  3. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2007. "Why Does Overnight Liquidity Cost More Than Intraday Liquidity?," Staff General Research Papers 13096, Iowa State University, Department of Economics.
  4. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2005. "Mechanism Design and Payments," 2005 Meeting Papers, Society for Economic Dynamics 11, Society for Economic Dynamics.
  5. Baglioni, Angelo & Monticini, Andrea, 2010. "The intraday interest rate under a liquidity crisis: The case of August 2007," Economics Letters, Elsevier, Elsevier, vol. 107(2), pages 198-200, May.
  6. Huberto M. Ennis & John A. Weinberg, 2007. "Interest on reserves and daylight credit," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Spr, pages 111-142.
  7. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers, Society for Economic Dynamics 282, Society for Economic Dynamics.
  8. Philipp Bagus & David Howden, 2012. "Still unanswered quibbles with fractional reserve free banking," The Review of Austrian Economics, Springer, Springer, vol. 25(2), pages 159-171, June.
  9. Fujiki, Hiroshi, 2014. "Institutional designs to alleviate liquidity shortages in a two-country model," Japan and the World Economy, Elsevier, Elsevier, vol. 31(C), pages 32-46.
  10. Chao Gu & Joseph Haslag, 2014. "Unconventional Optimal Open Market Purchases," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 543-558, July.
  11. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 18(1), pages 1-23, January.
  12. Jonathan Chiu & Alexandra Lai, 2007. "Modelling Payments Systems: A Review of the Literature," Working Papers, Bank of Canada 07-28, Bank of Canada.

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