Private and Public Supply of Liquidity
This paper addresses a basic yet unresolved question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the State have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means? In our model, firms can meet future liquidity needs in three ways: by issuing new claims and diluting old ones, by obtaining a credit credit line from a financial intermediary, and by holding claims on other firms. When there is no aggregate uncertainty, we show that these instruments are sufficient for attaining the socially optimal (second-best) contract between investors and firms. Such a contract imposes both a maximum leverage ratio and a liquidity constraint on firms. Intermediaries coordinate the use of liquidity. Without intermediation, scarce liquidity may be wasted and the social optimum may not be attainable. When there is only aggregate uncertainty the private sector is no longer self-sufficient with regard to liquidity. The government can improve liquidity by issuing bonds that commit future consumer income. Government bonds command a liquidity premium over private claims. The supply of liquidity can be managed by loosening liquidity (boosting the value of its securities) when the aggregate liquidity shock is high and tightening liquidity when the shock is low. The paper thus provides a microeconomic example of government supplied liquidity as well as of the possibility of active government policy.
|Date of creation:||Nov 1996|
|Date of revision:|
|Publication status:||published as Journal of Political Economy, Vol. 106, no. 1 (February 1998): 1-40.|
|Contact details of provider:|| Postal: |
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Williamson, S. & Wright, R., 1991.
"Barter and Monetary Exchange Under Private Information,"
University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers
9107, University of Western Ontario, The Centre for the Study of International Economic Relations.
- Williamson, Steve & Wright, Randall, 1994. "Barter and Monetary Exchange under Private Information," American Economic Review, American Economic Association, vol. 84(1), pages 104-23, March.
- Steve Williamson & Randall Wright, 1991. "Barter and monetary exchange under private information," Staff Report 141, Federal Reserve Bank of Minneapolis.
- Oliver Hart & John Moore, 1998.
"Default And Renegotiation: A Dynamic Model Of Debt,"
The Quarterly Journal of Economics,
MIT Press, vol. 113(1), pages 1-41, February.
- Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," NBER Working Papers 5907, National Bureau of Economic Research, Inc.
- Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
- Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," Harvard Institute of Economic Research Working Papers 1792, Harvard - Institute of Economic Research.
- Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," STICERD - Theoretical Economics Paper Series 321, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
- Stephen D. Williamson, 1984.
"Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing,"
583, Queen's University, Department of Economics.
- Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
- Ramakrishnan, Ram T S & Thakor, Anjan V, 1984. "Information Reliability and a Theory of Financial Intermediation," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 415-32, July.
- Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
- Bengt Holmstrom & Jean Tirole, 1994.
"Financial Intermediation, Loanable Funds and the Real Sector,"
95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
- Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
- Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers 40, Institut d'Économie Industrielle (IDEI), Toulouse.
- Elul Ronel, 1995. "Welfare Effects of Financial Innovation in Incomplete Markets Economies with Several Consumption Goods," Journal of Economic Theory, Elsevier, vol. 65(1), pages 43-78, February.
- Williamson, Stephen D., 1992. "Laissez-faire banking and circulating media of exchange," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 134-167, June.
- Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
- Hellwig, Martin, 1994. "Liquidity provision, banking, and the allocation of interest rate risk," European Economic Review, Elsevier, vol. 38(7), pages 1363-1389, August.
- Jeremy C. Stein, 1995.
"An Adverse Selection Model of Bank Asset and Liability Management with Implications for the Transmission of Monetary Policy,"
NBER Working Papers
5217, National Bureau of Economic Research, Inc.
- Jeremy C. Stein, 1998. "An Adverse-Selection Model of Bank Asset and Liability Management with Implications for the Transmission of Monetary Policy," RAND Journal of Economics, The RAND Corporation, vol. 29(3), pages 466-486, Autumn.
- Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:5817. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.