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A Theory of Money and Banking

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Author Info

  • David Andolfatto

    (Simon Fraser University)

  • Ed Nosal

    (Federal Reserve Bank of Cleveland)

Abstract

We construct a simple environment that combines a limited communication friction and a limited information friction in order to generate a role for money and intermediation. We ask whether there is any reason to expect the emergence of a banking sector (i.e., institutions that combine the business of money creation with the business of intermediation). In our model the unique equilibrium is characterized, in part, by the existence of an agent that: (1) creates money (a debt instrument that circulates as a means of payment); (2) lends it out (swapping it for less liquid forms of debt); (3) is responsible for monitoring those agents in control of the capital backing the illiquid debt; and (4) collects on money loans as they come due. Furthermore, the bank money in our model is a debt instrument that embeds within it important stipulations that are found in actual private money instruments. Thus, our model goes some way in addressing the questions of why private money takes the form that it does, as well as why private money is typically supplied by banks.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0310003.

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Length: 30 pages
Date of creation: 06 Oct 2003
Date of revision:
Handle: RePEc:wpa:wuwpma:0310003

Note: Type of Document - Tex; prepared on IBM PC; to print on Lexmark Optra E310; pages: 30; figures: included
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Web page: http://128.118.178.162

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Keywords: Money; Banking;

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References

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  1. 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.
  2. 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.
  3. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  4. David E. Laidler, 1988. "Taking Money Seriously," Canadian Journal of Economics, Canadian Economics Association, vol. 21(4), pages 687-713, November.
  5. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
  6. James Bullard & Bruce D. Smith, 2002. "Intermediaries and payments instruments," Working Papers 2002-006, Federal Reserve Bank of St. Louis.
  7. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  8. 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.
  9. 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.
  10. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
  11. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  12. Krasa, Stefan & Villamil, Anne P, 1992. "A Theory of Optimal Bank Size," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 725-49, October.
  13. Cavalcanti, Ricardo de Oliveira, 2003. "A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright," Economics Working Papers (Ensaios Economicos da EPGE) 476, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  14. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  15. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  16. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
  17. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "A model of private bank-note issue," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 104-136, January.
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Citations

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Cited by:
  1. Yi Wen, 2013. "Liquidity and Welfare," 2013 Meeting Papers 204, Society for Economic Dynamics.
  2. Hongfei Sun, 2006. "Aggregate Uncertainty, Money and Banking," 2006 Meeting Papers 58, Society for Economic Dynamics.
  3. Geoffrey Dunbar, 2005. "International Lending, Capital Controls and Wealth Inequality," 2005 Meeting Papers 492, Society for Economic Dynamics.
  4. Hongfei Sun, 2007. "Banking, Inside Money and Outside Money," Working Papers 1146, Queen's University, Department of Economics.
  5. Randall Wright & Lixin Huang & Ping He, 2008. "Money, Banking, and Monetary Policy," 2008 Meeting Papers 347, Society for Economic Dynamics.
  6. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
  7. Jonathan Chiu & Cesaire Meh, 2008. "Financial Intermediation, Liquidity and Inflation," Working Papers 08-49, Bank of Canada.

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  1. Advanced Monetary Theory and Policy (ECON 447)

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