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Banking with nominal deposits and inside money

  • Skeie, David R.

Bank runs in the literature take the form of withdrawals of demand deposits payable in real goods, which deplete a fixed reserve of goods in the banking system. That framework describes traditional bank runs based on currency withdrawals as occurred historically in the US and more recently in developing countries. However, in a modern banking system, large withdrawals typically take the form of electronic payments of inside money, with no analog of a depletion of a scarce reserve from the banking system. In a new framework of nominal demand deposits repayable in inside money, pure liquidity-driven bank runs do not occur. If there were excessive early withdrawals, nominal deposits would hedge the bank and flexible monetary prices in the goods market would limit real consumption. The maturity mismatch of short term liabilities and long term assets is not sufficient for multiple equilibria bank runs without other frictions. A key role of the bank is to ensure optimal real liquidity, which allows markets to optimally distribute consumption goods through the price mechanism.

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Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 17 (2008)
Issue (Month): 4 (October)
Pages: 562-584

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Handle: RePEc:eee:jfinin:v:17:y:2008:i:4:p:562-584
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