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Aggregate Liquidity Management

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  • Todd Keister
  • Daniel R. Sanches

Abstract

It has been largely acknowledged that monetary policy can affect borrowers and lenders differently. This paper investigates whether the distributional effects of monetary policy are an inherent feature of monetary economies with private credit instruments. In our framework, both money and credit instruments can potentially be used as media of exchange to overcome trading frictions in decentralized markets. Entrepreneurs have access to productive projects but face credit constraints due to limited pledgeability of their returns. Monetary policy affects the liquidity premium on private credit and thereby influences the cost of borrowing and the level of investment, but any attempt to ease borrowing constraints results in suboptimal decentralized-market trading activity. We show that this policy trade-off is not an inherent feature of monetary economies with private credit instruments. If we consider a richer set of aggregate liquidity management instruments, such as the payment of interest on inside money and capital requirements, it is possible to implement an efficient allocation.

Suggested Citation

  • Todd Keister & Daniel R. Sanches, 2016. "Aggregate Liquidity Management," Working Papers 16-32, Federal Reserve Bank of Philadelphia, revised 25 Nov 2016.
  • Handle: RePEc:fip:fedpwp:16-32
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    References listed on IDEAS

    as
    1. Holmström, Bengt, 2013. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262518536, December.
    2. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    3. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-864, November.
    4. Rocheteau, Guillaume & Wright, Randall, 2013. "Liquidity and asset-market dynamics," Journal of Monetary Economics, Elsevier, vol. 60(2), pages 275-294.
    5. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, vol. 135(1), pages 171-195, July.
    6. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
    7. Stephen D. Williamson, 2012. "Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach," American Economic Review, American Economic Association, vol. 102(6), pages 2570-2605, October.
    8. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
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    More about this item

    Keywords

    liquidity premium; monetary theory and policy; Friedman rule; bank lending channel; investment;

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