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The Optimal structure of Liquidity Provided by a Self Financed Central Bank

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Author Info
Miquel Faig

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Abstract

Central banks have consistently differentiated the return on the securities they have issued (money and national debt). In contrast, first best efficiency demands that these securities earn the same return: the return on capital. A self-financed central bank, without capital and taxes, cannot achieve this first best. The resulting gaps between the return on capital and the returns on public securities are implicit taxes. These taxes increase the opportunity costs of the commodities financed with the liquidation of these securities, so they are indirect taxes on these commodities. Because taxes on investment are less efficient than taxes on consumption, securities intensive in financing investment should be taxed at a lower rate than securities intensive in financing consumption. This is feasible if national debt is investment intensive. Then, this security should earn interest and be imposed artificial costs on second hand trading. In addition, because money is specialized in providing short term liquidity, raising the return on national debt delays expenditure toward the future. Hence, the payment of interest on national debt brings a windfall of resources during transitions across balanced paths in addition to the long term welfare gains of this policy. Similar arguments apply to short and long term maturities of the national debt.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number faig-99-01.

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Length: 35 pages
Date of creation: 26 Jan 1999
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Handle: RePEc:tor:tecipa:faig-99-01

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Find related papers by JEL classification:
E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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  1. Faig, Miquel, 1988. "Characterization of the optimal tax on money when it functions as a medium of exchange," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 137-148, July. [Downloadable!] (restricted)
  2. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June. [Downloadable!] (restricted)
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  3. Fried, Joel & Howitt, Peter, 1983. "The Effects of Inflation on Real Interest Rates," American Economic Review, American Economic Association, vol. 73(5), pages 968-80, December. [Downloadable!] (restricted)
  4. Bryant, John & Wallace, Neil, 1979. "The Inefficiency of Interest-bearing National Debt," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 365-81, April. [Downloadable!] (restricted)
  5. Bryant, John, 1980. " Nontransferable Interest-Bearing National Debt," Journal of Finance, American Finance Association, vol. 35(4), pages 1027-31, September. [Downloadable!] (restricted)
  6. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November. [Downloadable!] (restricted)
  7. Lawrence H. Summers, 1984. "The Nonadjustment of Nominal Interest Rates: A Study of the Fisher Effect," NBER Working Papers 0836, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February. [Downloadable!] (restricted)
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  9. Romer, David, 1993. "Why Should Governments Issue Bonds?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 163-75, May. [Downloadable!] (restricted)
  10. Alvarez, Fernando & Stokey, Nancy L., 1998. "Dynamic Programming with Homogeneous Functions," Journal of Economic Theory, Elsevier, vol. 82(1), pages 167-189, September. [Downloadable!] (restricted)
  11. Schreft, Stacey L. & Smith, Bruce D., 1997. "Money, Banking, and Capital Formation," Journal of Economic Theory, Elsevier, vol. 73(1), pages 157-182, March. [Downloadable!] (restricted)
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  12. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December. [Downloadable!] (restricted)
  13. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October. [Downloadable!] (restricted)
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  14. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  15. Foley, Duncan K & Hellwig, Martin F, 1975. "Asset Management with Trading Uncertainty," Review of Economic Studies, Blackwell Publishing, vol. 42(3), pages 327-46, July. [Downloadable!] (restricted)
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  16. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Oxford University Press, vol. 18(2), pages 203-20, April.
  17. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May. [Downloadable!] (restricted)
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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.)

  1. Miquel Faig & Gregory Gagnon, 2003. "Scarce Collateral and Bank Reserves," Working Papers faig-03-01, University of Toronto, Department of Economics. [Downloadable!]
    Other versions:
  2. Miquel Faig, 2000. "Money With Idiosyncratic Uninsurable Returns To Capital," Working Papers faig-00-01, University of Toronto, Department of Economics. [Downloadable!]
    Other versions:
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