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Liquidity Crises and Discount Window Lending: Theory and Implications for the Dollarization Debate

  • Gaetano Antinolfi

    ()

    (Washington University)

  • Todd Keister

    ()

    (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))

We study the consequences of a central bank providing an elastic currency through the use of discount window lending. In particular, we compare the set of equilibria generated when the interest rate is fixed in nominal terms with that generated when it is fixed in real terms. The two policies generate the same steady state equilibrium. However, fixing the nominal interest rate always generates additional, inflationary equilibria while the while fixing the real rate never does, regardless of the rate chosen. We argue that dollarization can be viewed as a mechanism for committing to having a fixed real interest rate on short-term credit, and discuss some implications of this analysis for the current debate in Mexico.

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File URL: http://ftp.itam.mx/pub/academico/inves/keister/00-02.pdf
File Function: First version, 2000
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Paper provided by Centro de Investigacion Economica, ITAM in its series Working Papers with number 0002.

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Length: 28 pages
Date of creation: Sep 2000
Date of revision:
Handle: RePEc:cie:wpaper:0002
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  1. Williamson, S.D., 1995. "Discount Window Lending and Deposit Insurance," Working Papers 95-01, University of Iowa, Department of Economics.
  2. Eichengreen, Barry, 2002. "When to Dollarize," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 1-24, February.
  3. Alberto Alesina, 1988. "Macroeconomics and Politics," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 13-62 National Bureau of Economic Research, Inc.
  4. Gaetano Antinolfi & Elisabeth Huybens & Todd Keister, 2000. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Working Papers 0001, Centro de Investigacion Economica, ITAM.
  5. Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
  6. Bruce D. Smith & Warren E. Weber, 1998. "Private money creation and the Suffolk Banking System," Working Papers 591, Federal Reserve Bank of Minneapolis.
  7. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  8. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
  9. Hornstein, Andreas & Krusell, Per, 1993. "Money and Insurance in a Turnpike Environment," Economic Theory, Springer, vol. 3(1), pages 19-34, January.
  10. Balasko, Yves & Shell, Karl, 1981. "The overlapping-generations model. II. The case of pure exchange with money," Journal of Economic Theory, Elsevier, vol. 24(1), pages 112-142, February.
  11. Mitsui, Toshihide & Watanabe, Shinichi, 1989. "Monetary growth in a turnpike environment," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 123-137, July.
  12. Sargent, Thomas J & Wallace, Neil, 1982. "The Real-Bills Doctrine versus the Quantity Theory: A Reconsideration," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1212-36, December.
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