Liquidity needs in economies with interconnected financial obligations
AbstractA model is developed in which firms in a financial system have to settle their debts to each other by using a liquid asset (or money). The question studied is how many firms must have access to this asset from outside the financial system to make sure that all debts within the system are settled. The main result is that these liquidity needs are larger when these firms are more interconnected through their debts, that is, when they borrow from and lend to more firms. Two pecuniary externalities are discussed. One is the result of paying one creditor first rather than another. The second occurs when firms increase their financial transactions and thereby make it more likely that others will default. Finally, the paper shows that interconnections can raise the number of firms that must be endowed with liquidity even when payments paths are chosen by a planner that seeks to avoid defaults.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Atlanta in its series CQER Working Paper with number 2009-01.
Date of creation: 2010
Date of revision:
Other versions of this item:
- Julio J. Rotemberg, 2008. "Liquidity Needs in Economies with Interconnected Financial Obligations," NBER Working Papers 14222, National Bureau of Economic Research, Inc.
- D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
- D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
- G20 - Financial Economics - - Financial Institutions and Services - - - General
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