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Money, credit and banking

  • Berentsen, Aleksander
  • Camera, Gabriele
  • Waller, Christopher

We use a modified version of the Lagos-Wright model to introduce an essential role for banks. Due to preference shocks, agents have excess demand for or supply of money balances. Banks arise to reallocate excess cash by taking deposits from sellers and making loans to buyers. We consider two variations of the model: one in which buyers borrow to finance consumption and another in which they borrow to finance investment. We show that for any positive nominal interest rate, the existence of banks leads to a higher level of steady state output and welfare. We also derive conditions under which borrowers voluntarily repay loans. Finally, we examine how monetary injections into the banking system affect the economy. The effects are very similar to limited particiption models and gives rise to a liquidity effect on nominal interest rates

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 135 (2007)
Issue (Month): 1 (July)
Pages: 171-195

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Handle: RePEc:eee:jetheo:v:135:y:2007:i:1:p:171-195
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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