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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 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. Hyun Song Shin & Stephen Morris, 2004. "Liquidity Black Holes," Econometric Society 2004 North American Winter Meetings 644, Econometric Society.
  2. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
  3. P. A. Diamond, 1982. "Money in Search Equilibrium," Working papers 297, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. 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.
  6. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Liquidity Shortages and Banking Crises," NBER Working Papers 10071, National Bureau of Economic Research, Inc.
  7. 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.
  8. Martin Shubik, 2000. "The Theory of Money," Cowles Foundation Discussion Papers 1253, Cowles Foundation for Research in Economics, Yale University.
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