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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.econ.yale.edu/P/cd/d14b/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.
Contact details of provider: Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Phone: (203) 432-3702
Fax: (203) 432-6167
Web page: http://cowles.econ.yale.edu/

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

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  1. Martin Shubik, 2000. "The Theory of Money," Working Papers 00-03-021, Santa Fe Institute.
  2. Stephen Morris & Hyun Song Shin, 2003. "Liquidity Black Holes," Cowles Foundation Discussion Papers 1434, Cowles Foundation for Research in Economics, Yale University.
  3. 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.
  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. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Liquidity Shortages and Banking Crises," NBER Working Papers 10071, National Bureau of Economic Research, Inc.
  7. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
  8. Roberto Chang & Andrés Velasco, 2000. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Chapters, in: NBER Macroeconomics Annual 1999, Volume 14, pages 11-78 National Bureau of Economic Research, Inc.
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