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Why does overnight liquidity cost more than intraday liquidity?

  • Joydeep Bhattacharya
  • Joseph H. Haslag
  • Antoine Martin

In this paper, we argue that the observed difference in the cost of intraday and overnight liquidity is part of an optimal payments system design. In our environment, the interest charged on overnight liquidity affects output, while the cost of intraday liquidity only affects the distribution of resources between money holders and non-money holders. The low cost of intraday liquidity follows from the Friedman rule, but with respect to overnight liquidity, it is optimal to deviate from the Friedman rule. The cost differential simultaneously reduces the incentive to overuse money and encourages risk sharing.>

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 281.

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Date of creation: 2007
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Handle: RePEc:fip:fednsr:281
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  8. Joseph H. Haslag & Joydeep Bhattacharya & Antoine Martin, 2007. "Money, output and the payment system: Optimal monetary policy in a model with hidden effort," Working Papers 0704, Department of Economics, University of Missouri.
  9. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  10. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Wiley Blackwell, vol. 70(3), pages 569-587, 07.
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  13. Bhattacharya, Joydeep & Haslag, Joseph H. & Martin, Antoine, 2006. "Sub-optimality of the Friedman rule in Townsend's turnpike and stochastic relocation models of money: Do finite lives and initial dates matter?," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 879-897, May.
  14. Champ, B. & Smith, B.D., 1991. "Currency Elasticity and Banking Panics: theory and Evidence," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9109, University of Western Ontario, The Centre for the Study of International Economic Relations.
  15. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2004. "Heterogeneity, redistribution, and the Friedman rule," Research Working Paper RWP 04-01, Federal Reserve Bank of Kansas City.
  16. Green, Edward-J, 1997. "Money and Debt in the Structure of Payments," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 15(1), pages 63-87, May.
  17. Paul M Romer, 1999. "Increasing Returns and Long-Run Growth," Levine's Working Paper Archive 2232, David K. Levine.
  18. Joseph H. Haslag & Antoine Martin, 2007. "Optimality of the Friedman Rule in an Overlapping Generations Model with Spatial Separation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1741-1758, October.
  19. David C. Mills, Jr, 2004. "Mechanism Design and the Role of Enforcement in Freeman's Model of Payments," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 219-236, january.
  20. Leonardo Bartolini & Svenja Gudell & R. Spence Hilton & Krista B. Schwarz, 2005. "Intraday trading in the overnight federal funds market," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 11(Nov).
  21. Ruilin Zhou, 2000. "Understanding intraday credit in large-value payment systems," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 29-44.
  22. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
  23. Carlos E. da Costa & Iván Werning, 2008. "On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 116(1), pages 82-112, 02.
  24. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  25. Bhattacharya, Joydeep & Singh, Rajesh, 2008. "Usefulness Of The Constrained Planning Problem In A Model Of Money," Macroeconomic Dynamics, Cambridge University Press, vol. 12(04), pages 503-525, September.
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