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Alternative central bank credit policies for liquidity provision in a model of payments

  • Mills, David Jr.

I explore alternative central bank policies for liquidity provision in a model of payments. I use a mechanism design approach so that agents' incentives to default are explicit and contingent on the credit policy designed. In the first policy, the central bank invests in costly enforcement and charges an interest rate to recover costs. I show that the second best solution is not distortionary. In the second policy, the central bank requires collateral. If collateral does not bear an opportunity cost, then the solution is first best. Otherwise, the second best is distortionary because collateral serves as a binding credit constraint.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 53 (2006)
Issue (Month): 7 (October)
Pages: 1593-1611

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Handle: RePEc:eee:moneco:v:53:y:2006:i:7:p:1593-1611
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. Martin, Antoine, 2004. "Optimal pricing of intraday liquidity," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 401-424, March.
  2. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  3. Kahn, Charles M. & Roberds, William, 2001. "Real-time gross settlement and the costs of immediacy," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 299-319, April.
  4. Ruilin Zhou, 2000. "Understanding intraday credit in large-value payment systems," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 29-44.
  5. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
  6. Jean-Charles Rochet & Jean Tirole, 1996. "Controlling risk in payment systems," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 832-869.
  7. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  8. Townsend, Robert M, 1989. "Currency and Credit in a Private Information Economy," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1323-44, December.
  9. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
  10. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  11. Bech, Morten L. & Garratt, Rod, 2001. "The Intraday Liquidity Management Game," University of California at Santa Barbara, Economics Working Paper Series qt0m6035wg, Department of Economics, UC Santa Barbara.
  12. David C. Mills, Jr, 2004. "Mechanism Design and the Role of Enforcement in Freeman's Model of Payments," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 219-236, january.
  13. Kobayakawa, Shuji, 1997. "The Comparative Analysis of Settlement Systems," CEPR Discussion Papers 1667, C.E.P.R. Discussion Papers.
  14. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
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