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Collateral restrictions and liquidity under-supply: a simple model

  • Ana Fostel

    ()

  • John Geanakoplos

    ()

We show that very little is needed to create liquidity under-supply in equilibrium. Credit constraints on demand by themselves can cause an under-supply of liquidity, without the uncertainty, intermediation, asymmetric information or complicated international financial framework used in other models in the literature. We show that the under-supply is a non-monotone function of the demand distortion that causes it, a result that may have interesting implications for emerging markets economies. Finally, when we make the credit constraint endogenous, the inefficiency can be large due to the presence of a multiplier.

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File URL: http://hdl.handle.net/10.1007/s00199-007-0253-4
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Article provided by Springer & Society for the Advancement of Economic Theory (SAET) in its journal Economic Theory.

Volume (Year): 35 (2008)
Issue (Month): 3 (June)
Pages: 441-467

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Handle: RePEc:spr:joecth:v:35:y:2008:i:3:p:441-467
DOI: 10.1007/s00199-007-0253-4
Contact details of provider: Web page: http://www.springer.com

Web page: http://saet.uiowa.edu/

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  1. Douglas W. Diamond & Raghuram G. Rajan, 2002. "Liquidity Shortages and Banking Crises," NBER Working Papers 8937, National Bureau of Economic Research, Inc.
  2. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University.
  3. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Review of Finance, Springer, vol. 8(1), pages 1-18.
  4. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
  5. Diamond, Peter A, 1984. "Money in Search Equilibrium," Econometrica, Econometric Society, vol. 52(1), pages 1-20, January.
  6. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  7. R. G. Lipsey & Kelvin Lancaster, 1956. "The General Theory of Second Best," Review of Economic Studies, Oxford University Press, vol. 24(1), pages 11-32.
  8. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Martin Shubik, 2000. "The Theory of Money," Working Papers 00-03-021, Santa Fe Institute.
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