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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. Martin Shubik, 2000. "The Theory of Money," Cowles Foundation Discussion Papers 1253, Cowles Foundation for Research in Economics, Yale University.
  2. 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.
  3. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Roberto Chang & Andres Velasco, 1999. "Liquidity crises in emerging markets: Theory and policy," Working Paper 99-15, Federal Reserve Bank of Atlanta.
  5. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Yale School of Management Working Papers ysm425, Yale School of Management.
  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. Jones, Robert A & Ostroy, Joseph M, 1984. "Flexibility and Uncertainty," Review of Economic Studies, Wiley Blackwell, vol. 51(1), pages 13-32, January.
  8. Diamond, Peter A, 1984. "Money in Search Equilibrium," Econometrica, Econometric Society, vol. 52(1), pages 1-20, January.
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