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A theory of money and banking

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  • David Andolfatto
  • Ed Nosal

Abstract

The authors construct a simple environment that combines a limited communication friction and a limited information friction in order to generate a role for money and intermediation. They ask whether there is any reason to expect the emergence of a banking sector (i.e., institutions that combine the business of money creation with the business of intermediation). In their model, the unique equilibrium is characterized partly by the existence of an agent that: (1) creates money (a debt instrument that circulates as a means of payment); (2) lends it out (swapping it for less liquid forms of debt); (3) is responsible for monitoring those agents in control of the capital backing the illiquid debt; and (4) collects on money loans as they come due.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 0310.

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Date of creation: 2003
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Handle: RePEc:fip:fedcwp:0310

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Keywords: Money ; Banks and banking ; Information theory;

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References

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  1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  2. 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.
  3. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  4. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  5. 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).
  6. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  7. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers 583, Queen's University, Department of Economics.
  8. Laidler, D., 1988. "Taking Money Seriously," UWO Department of Economics Working Papers 8804, University of Western Ontario, Department of Economics.
  9. 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.
  10. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  11. 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.
  12. Bullard, James & Smith, Bruce D., 2003. "Intermediaries and payments instruments," Journal of Economic Theory, Elsevier, vol. 109(2), pages 172-197, April.
  13. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
  14. Krasa, Stefan & Villamil, Anne P, 1992. "A Theory of Optimal Bank Size," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 725-49, October.
  15. David Andolfatto & Ed Nosal, 2001. "A simple model of money and banking," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 20-28.
  16. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  17. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
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Citations

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Cited by:
  1. Hongfei Sun, 2006. "Aggregate Uncertainty, Money and Banking," 2006 Meeting Papers 58, Society for Economic Dynamics.
  2. Yi Wen, 2012. "Liquidity and welfare," Working Papers 2012-037, Federal Reserve Bank of St. Louis.
  3. Randall Wright & Lixin Huang & Ping He, 2008. "Money, Banking, and Monetary Policy," 2008 Meeting Papers 347, Society for Economic Dynamics.
  4. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
  5. Geoffrey Dunbar, 2005. "International Lending, Capital Controls and Wealth Inequality," 2005 Meeting Papers 492, Society for Economic Dynamics.
  6. Hongfei Sun, 2007. "Banking, Inside Money and Outside Money," Working Papers 1146, Queen's University, Department of Economics.
  7. Chiu, Jonathan & Meh, Césaire A., 2011. "Financial Intermediation, Liquidity, And Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 83-118, April.

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