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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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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
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  1. Diamond, Peter A, 1984. "Money in Search Equilibrium," Econometrica, Econometric Society, vol. 52(1), pages 1-20, January.
  2. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Liquidity Shortages and Banking Crises," NBER Working Papers 10071, National Bureau of Economic Research, Inc.
  3. Martin Shubik, 2000. "The Theory of Money," Working Papers 00-03-021, Santa Fe Institute.
  4. Hyun Song Shin & Stephen Morris, 2004. "Liquidity Black Holes," Econometric Society 2004 North American Winter Meetings 644, Econometric Society.
  5. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
  6. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. 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.
  8. Roberto Chang & Andres Velasco, 1999. "Liquidity crises in emerging markets: Theory and policy," FRB Atlanta Working Paper 99-15, Federal Reserve Bank of Atlanta.
  9. 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.
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