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Banking, Inside Money and Outside Money

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  • Hongfei Sun

    ()
    (Queen's University)

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 makes it less costly to induce truthful revelation and achieve more efficient risk sharing.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1146.pdf
File Function: First version 2007
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1146.

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Length: 43 pages
Date of creation: Dec 2007
Date of revision:
Handle: RePEc:qed:wpaper:1146

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Keywords: banking; inside money; outside money;

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References

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  1. Miquel Faig, 2004. "Divisible Money in an Economy with Villages," Levine's Bibliography 122247000000000159, UCLA Department of Economics.
  2. Shi, Shouyong, 1996. "Credit and Money in a Search Model with Divisible Commodities," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 627-52, October.
  3. David Andolfatto & Ed Nosal, 2003. "A Theory of Money and Banking," Macroeconomics 0310003, EconWPA.
  4. 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.
  5. 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.
  6. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 427-53, July.
  7. 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.
  8. James Bullard & Bruce D. Smith, 2001. "The value of inside and outside money," Working Papers 2000-027, Federal Reserve Bank of St. Louis.
  9. Sun, Hongfei, 2007. "Aggregate uncertainty, money and banking," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1929-1948, October.
  10. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  11. 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.
  12. 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.
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Cited by:
  1. Allen Head & Junfeng Qiu, 2011. "Elastic Money, Inflation, and Interest Rate Policy," Working Papers 1152, Queen's University, Department of Economics.
  2. Mei Dong, 2011. "Money and Costly Credit," Working Papers 11-7, Bank of Canada.

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