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Financial Intermediation, Liquidity, And Inflation

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  • 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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    References listed on IDEAS

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    1. David Andolfatto & Ed Nosal, 2003. "A theory of money and banking," Working Paper 0310, Federal Reserve Bank of Cleveland.
    2. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    3. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, vol. 135(1), pages 171-195, July.
    4. 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, May.
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    Citations

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    Cited by:

    1. 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(08), pages 1854-1883, December.
    2. Jonathan Chiu & Mei Dong & Enchuan Shao, 2012. "On the Welfare Effects of Credit Arrangements," Staff Working Papers 12-43, Bank of Canada.
    3. 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.
    4. 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.
    5. 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.
    6. 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.
    7. repec:eee:dyncon:v:89:y:2018:i:c:p:100-116 is not listed on IDEAS
    8. repec:dau:papers:123456789/7353 is not listed on IDEAS
    9. Valencia, Fabián, 2014. "Banks' Precautionary Capital And Credit Crunches," Macroeconomic Dynamics, Cambridge University Press, vol. 18(08), pages 1726-1750, December.

    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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