Banking, Inside Money and Outside Money
AbstractThis 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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Bibliographic InfoPaper provided by Queen's University, Department of Economics in its series Working Papers with number 1146.
Length: 43 pages
Date of creation: Dec 2007
Date of revision:
banking; inside money; outside money;
Other versions of this item:
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- G2 - Financial Economics - - Financial Institutions and Services
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-12-08 (All new papers)
- NEP-BAN-2007-12-08 (Banking)
- NEP-CBA-2007-12-08 (Central Banking)
- NEP-DGE-2007-12-08 (Dynamic General Equilibrium)
- NEP-MAC-2007-12-08 (Macroeconomics)
- NEP-MON-2007-12-08 (Monetary Economics)
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