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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 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
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  1. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, vol. 60(2), pages 615-647, 04.
  2. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Review of Finance, Springer, vol. 8(1), pages 1-18.
  3. Roberto Chang & Andres Velasco, 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Working Papers 7272, National Bureau of Economic Research, Inc.
  4. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  5. P. A. Diamond, 1982. "Money in Search Equilibrium," Working papers 297, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  7. Martin Shubik, 2000. "The Theory of Money," Cowles Foundation Discussion Papers 1253, Cowles Foundation for Research in Economics, Yale University.
  8. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
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