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Alternative central bank credit policies for liquidity provision in a model of payments

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  • David C. Mills, Jr.

Abstract

I explore alternative central bank policies for liquidity provision in a model of payments. I use a mechanism design approach so that agents' incentives to default are explicit and contingent on the credit policy designed. In the first policy, the central bank invests in costly enforcement and charges an interest rate to recover costs. I show that the second best solution is not distortionary. In the second policy, the central bank requires collateral. If collateral does not bear an opportunity cost, then the solution is first best. Otherwise, the second best is distortionary because collateral serves as a binding credit constraint.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-55.

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Date of creation: 2005
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Handle: RePEc:fip:fedgfe:2005-55

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Keywords: Payment systems ; Bank liquidity ; Banks and banking; Central;

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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, vol. 109(2), pages 198-219, April.
  2. Jean-Charles Rochet & Jean Tirole, 1996. "Controlling risk in payment systems," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 832-869.
  3. Ruilin Zhou, 2000. "Understanding intraday credit in large-value payment systems," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 29-44.
  4. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  5. 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.
  6. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  7. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  8. Kahn, Charles M. & Roberds, William, 2001. "Real-time gross settlement and the costs of immediacy," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 299-319, April.
  9. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
  10. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  11. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
  12. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  13. Townsend, Robert M, 1989. "Currency and Credit in a Private Information Economy," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1323-44, December.
  14. Kobayakawa, Shuji, 1997. "The Comparative Analysis of Settlement Systems," CEPR Discussion Papers 1667, C.E.P.R. Discussion Papers.
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Cited by:
  1. Baglioni, Angelo & Monticini, Andrea, 2010. "The intraday interest rate under a liquidity crisis: The case of August 2007," Economics Letters, Elsevier, vol. 107(2), pages 198-200, May.
  2. Huberto M. Ennis & John A. Weinberg, 2007. "Interest on reserves and daylight credit," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 111-142.
  3. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2007. "Why does overnight liquidity cost more than intraday liquidity?," Staff Reports 281, Federal Reserve Bank of New York.
  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. 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, vol. 94(1), pages 329-338.
  6. Philipp Bagus & David Howden, 2012. "Still unanswered quibbles with fractional reserve free banking," The Review of Austrian Economics, Springer, vol. 25(2), pages 159-171, June.
  7. Jonathan Chiu & Alexandra Lai, 2007. "Modelling Payments Systems: A Review of the Literature," Working Papers 07-28, Bank of Canada.
  8. Antoine Martin & James McAndrews, 2008. "Should there be intraday money markets?," Staff Reports 337, Federal Reserve Bank of New York.
  9. 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.
  10. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2005. "Mechanism Design and Payments," 2005 Meeting Papers 11, Society for Economic Dynamics.
  11. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.
  12. Hiroshi Fujiki, 2013. "Institutional Designs to Alleviate Liquidity Shortages in a Two- Country Model," IMES Discussion Paper Series 13-E-07, Institute for Monetary and Economic Studies, Bank of Japan.

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