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Financial Intermediation, Liquidity, And Inflation

Author

Listed:
  • Chiu, Jonathan
  • Meh, Césaire A.

Abstract

This paper develops a search-theoretic model to study the interaction between banking and monetary policy and how this interaction affects allocation and welfare. Regarding how banking affects the welfare costs of inflation, we find that, with banking, inflation generates lower welfare costs. We also find that lowering inflation improves welfare not just by reducing consumption/production distortions, but also by avoiding financial intermediation costs. Therefore, understanding the nature of financial intermediation is critical for accurately assessing the welfare gain from lowering the inflation rate. Regarding how monetary policy affects the welfare effects of banking, we find that, when the inflation is low, banking is not active in channeling liquidity; when inflation is high, banking is active and improves welfare; and when inflation is moderate, banking is active but reduces welfare. Owing to general-equilibrium feedback, banking is supported in equilibrium even though welfare is higher without banking.

Suggested Citation

  • Chiu, Jonathan & Meh, Césaire A., 2011. "Financial Intermediation, Liquidity, And Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 83-118, April.
    • Handle: RePEc:cup:macdyn:v:15:y:2011:i:s1:p:83-118_00
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    Cited by:

    1. Guillaume Rocheteau & Randall Wright & Cathy Zhang, 2018. "Corporate Finance and Monetary Policy," American Economic Review, American Economic Association, vol. 108(4-5), pages 1147-1186, April.
    2. Jonathan Chiu & Cesaire Meh & Randall Wright, 2017. "Innovation And Growth With Financial, And Other, Frictions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 58(1), pages 95-125, February.
    3. Chadha, Jagjit S. & Corrado, Luisa & Holly, Sean, 2014. "A Note On Money And The Conduct Of Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 18(8), pages 1854-1883, December.
    4. Rafael Silveira & Randall Wright, 2016. "Venture Capital: A Model of Search and Bargaining," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 19, pages 232-246, January.
    5. Mohammed Ait Lahcen & Pedro Gomis‐Porqueras, 2021. "A Model of Endogenous Financial Inclusion: Implications for Inequality and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(5), pages 1175-1209, August.
    6. Valencia, Fabián, 2014. "Banks' Precautionary Capital And Credit Crunches," Macroeconomic Dynamics, Cambridge University Press, vol. 18(8), pages 1726-1750, December.
    7. Gu, Chao & Monnet, Cyril & Nosal, Ed & Wright, Randall, 2023. "Diamond–Dybvig and beyond: On the instability of banking," European Economic Review, Elsevier, vol. 154(C).
    8. Mariana Rojas Breu, 2013. "The Welfare Effect Of Access To Credit," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 235-247, January.
    9. Aleksander Berentsen & Guido Menzio & Randall Wright, 2011. "Inflation and Unemployment in the Long Run," American Economic Review, American Economic Association, vol. 101(1), pages 371-398, February.
    10. Wright, Randall & Xiao, Sylvia Xiaolin & Zhu, Yu, 2018. "Frictional capital reallocation I: Ex ante heterogeneity," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 100-116.
    11. repec:dau:papers:123456789/7353 is not listed on IDEAS
    12. Jonathan Chiu & Cesaire Meh & Randall Wright, 2017. "Innovation And Growth With Financial, And Other, Frictions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 58, pages 95-125, February.
    13. Jonathan Chiu & Mei Dong & Enchuan Shao, 2018. "On The Welfare Effects Of Credit Arrangements," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(3), pages 1621-1651, August.
    14. Ndwiga, David & Makunda, Geraldine, 2025. "Macroeconomic imbalances evolution and their effect on bank intermediation cost in Kenya," KBA Centre for Research on Financial Markets and Policy Working Paper Series 93, Kenya Bankers Association (KBA).

    More about this item

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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