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Collateral Restrictions and Liquidity Under-Supply: A Simple Model

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://cowles.yale.edu/sites/default/files/files/pub/d14/d1468-r.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1468R.

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Length: 31 pages
Date of creation: Jun 2004
Date of revision: Aug 2006
Publication status: Published in Economic Theory (2008), 35: 441-467
Handle: RePEc:cwl:cwldpp:1468r
Note: CFP 1236.
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Web page: http://cowles.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

References listed on IDEAS
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  1. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Review of Finance, Springer, vol. 8(1), pages 1-18.
  2. Martin Shubik, 2000. "The Theory of Money," Working Papers 00-03-021, Santa Fe Institute.
  3. Diamond, Peter A, 1984. "Money in Search Equilibrium," Econometrica, Econometric Society, vol. 52(1), pages 1-20, January.
  4. Douglas W. Diamond & Raghuram G. Rajan, 2002. "Liquidity Shortages and Banking Crises," NBER Working Papers 8937, National Bureau of Economic Research, Inc.
  5. Roberto Chang & Andres Velasco, 1999. "Liquidity crises in emerging markets: Theory and policy," FRB Atlanta Working Paper 99-15, Federal Reserve Bank of Atlanta.
  6. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
  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. repec:oup:restud:v:51:y:1984:i:1:p:13-32 is not listed on IDEAS
  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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