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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 credit policies in a theoretical model where (i) money is necessary as a means of payment, (ii) there is a shortage of liquidity that a central bank addresses through the extension of credit, (iii) money is necessary to repay debts, and (iv) the incentives to default are explicit and contingent on the credit policy designed. Using a mechanism design approach, I compare a credit policy of charging an interest rate on credit (like the Federal Reserve's policy) with that of requiring the posting of collateral (like the European Central Bank's policy). I find that the pricing policy can implement good allocations while the collateral policy cannot whenever collateral bears an opportunity cost

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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
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  1. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  2. 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.
  3. 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.
  4. Kobayakawa, Shuji, 1997. "The Comparative Analysis of Settlement Systems," CEPR Discussion Papers 1667, C.E.P.R. Discussion Papers.
  5. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
  6. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  7. Bech, Morten L. & Garratt, Rod, 2003. "The intraday liquidity management game," Journal of Economic Theory, Elsevier, vol. 109(2), pages 198-219, April.
  8. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
  9. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  10. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  11. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," FRB Atlanta Working Paper 98-21, Federal Reserve Bank of Atlanta.
  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. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  14. Ruilin Zhou, 2000. "Understanding intraday credit in large-value payment systems," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 29-44.
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