Banking, Inside Money and Outside Money

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Banking, Inside Money and Outside Money

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Sun, Hongfei

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Hongfei Sun

Abstract

This paper presents an integrated theory of money and banking. I address the following question: when both individuals and banks have private information, what is the optimal way to settle debts? I develop a dynamic model with micro-founded roles for banks and a medium of exchange. I establish two main results: first, markets can improve upon the optimal dynamic contract at the presence of private information. Market prices fully reveal the aggregate states and help solve the incentive problem of the bank. Secondly, it is optimal for the bank to require loans be settled with short-term inside money, i.e. bank money that expires immediately after the settlement of debts. Short-term inside money dominates outside money because the former makes it less costly to induce truthful revelation and achieve more efficient risk sharing.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4504.

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Date of creation: Aug 2007
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Handle: RePEc:pra:mprapa:4504

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Other versions of this item:

Paper
- Hongfei Sun, 2007. "Banking, Inside Money and Outside Money," Working Papers 1146, Queen's University, Department of Economics. [Downloadable!]

Find related papers by JEL classification:
G2 - Financial Economics - - Financial Institutions and Services
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

This paper has been announced in the following NEP Reports:

NEP-ALL-2007-08-18 (All new papers)
NEP-BAN-2007-08-18 (Banking)
NEP-DGE-2007-08-18 (Dynamic General Equilibrium)
NEP-MAC-2007-08-18 (Macroeconomics)
NEP-MON-2007-08-18 (Monetary Economics)

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Hongfei Sun, 2006. "Aggregate Uncertainty, Money and Banking," 2006 Meeting Papers 58, Society for Economic Dynamics. [Downloadable!]
Other versions:
- Sun, Hongfei, 2007. "Aggregate uncertainty, money and banking," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1929-1948, October. [Downloadable!] (restricted)
Shi, Shouyong, 1996. "Credit and Money in a Search Model with Divisible Commodities," Review of Economic Studies, Blackwell Publishing, vol. 63(4), pages 627-52, October. [Downloadable!] (restricted)
Other versions:
- Shouyong Shi, 1995. "Credit and Money in a Search Model with Divisible Commodities," Working Papers 917, Queen's University, Department of Economics.
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. [Downloadable!] (restricted)
Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Blackwell Publishing, vol. 59(3), pages 427-53, July. [Downloadable!] (restricted)
Bullard, James & Smith, Bruce D., 2003. "The value of inside and outside money," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 389-417, March. [Downloadable!] (restricted)
Other versions:
- James Bullard & Bruce D. Smith, 2001. "The value of inside and outside money," Working Papers 2000-027, Federal Reserve Bank of St. Louis. [Downloadable!]
Miquel Faig, 2006. "Divisible Money In An Economy With Villages," Working Papers tecipa-216, University of Toronto, Department of Economics. [Downloadable!]
Other versions:
- Miquel Faig, 2004. "Divisible Money in an Economy with Villages," Econometric Society 2004 North American Summer Meetings 248, Econometric Society. [Downloadable!]
- Miquel Faig, 2004. "Divisible Money in an Economy with Villages," Levine's Bibliography 122247000000000159, UCLA Department of Economics. [Downloadable!]
Aiyagari, S. Rao & Williamson, Stephen D., 2000. "Money and Dynamic Credit Arrangements with Private Information," Journal of Economic Theory, Elsevier, vol. 91(2), pages 248-279, April. [Downloadable!] (restricted)
Other versions:
- S. Rao Aiyagari & Stephen D. Williamson, 1998. "Money and dynamic credit arrangements with private information," Working Paper 9807, Federal Reserve Bank of Cleveland. [Downloadable!]
- Aiyagari, S. Rao & Williamson, Stephen, 1997. "Money and Dynamic Credit Arrangements with Private Information," Working Papers 97-19, University of Iowa, Department of Economics.
- S. Rao Aiyagari & Stephen D. Williamson, 1998. "Money and Dynamic Credit Arrangements with Private Information," Game Theory and Information 9802002, EconWPA. [Downloadable!]
David Andolfatto & Ed Nosal, 2003. "A theory of money and banking," Working Paper 0310, Federal Reserve Bank of Cleveland. [Downloadable!]
Other versions:
- David Andolfatto & Ed Nosal, 2003. "A Theory of Money and Banking," Macroeconomics 0310003, EconWPA. [Downloadable!]
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.
Other versions:
- Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
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. [Downloadable!]
Stephen Williamson, 2004. "Limited participation, private money, and credit in a spatial model of money," Economic Theory, Springer, vol. 24(4), pages 857-875, November. [Downloadable!] (restricted)
Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August. [Downloadable!] (restricted)

Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Allen Head & Junfeng Qiu, 2007. "Elastic Money, Inflation, and Interest Rate Policy," Working Papers 1152, Queen's University, Department of Economics. [Downloadable!]

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