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The welfare benefits of stable and efficient payment systems

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  • Stephen P Millard

    (Bank of England)

  • Matthew Willison

    (Bank of England)

Abstract

The Bank of England's second core purpose is to maintain the stability of the financial system. Payment systems, by supporting transactions, are a key aspect of this. In this paper, we examine the importance of smoothly functioning payment systems to the economy by extending a recently developed theoretical model of banks. In the model the risk of theft implies a cost to using cash. This risk can be avoided by depositing cash in banks and transferring money through an interbank payment system. However, agents are then exposed to the risk that the payment system is unreliable. Agents will use a payment system (rather than cash) to make transactions if the system is sufficiently cheap to use and/or it is sufficiently reliable. We show that the introduction of a payment system that buyers and producers choose to use unambiguously increases social welfare if it expands the number of trades occurring in the economy. This is more likely the more reliable is the payment system. When the introduction of a payment system does not increase the number of trades, social welfare may increase or decrease depending on the trade-off between the risk of using cash and the risk that the payment system is unreliable. We again show that the more reliable is the payment system, the more likely welfare is increased by its introduction and we illustrate how this benefit might be quantified.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2004 with number 36.

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Date of creation: 17 Sep 2004
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Handle: RePEc:mmf:mmfc04:36

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Web page: http://www.essex.ac.uk/afm/mmf/index.html

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  1. Giovanni Immordino & Marco Pagano, 2009. "Legal Standards, Enforcement and Corruption," EIEF Working Papers Series 0914, Einaudi Institute for Economics and Finance (EIEF), revised Oct 2009.
  2. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  3. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  4. 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.
  5. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  6. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.
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Cited by:
  1. Massimo Cirasino & Mario Guadamillas & José Antonio García & Fernando Montes-Negret, 2007. "Reforming Payments and Securities Settlement Systems in Latin America and the Caribbean," World Bank Publications, The World Bank, number 6630, July.

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