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Banking, Inside Money and Outside Money

  • Hongfei Sun

    ()

    (Queen's University)

This paper presents an integrated theory of money and banking. I address the following question: when both individuals and banks have private information, what is the optimal way to settle debts? I develop a dynamic model with micro-founded roles for banks and a medium of exchange. I establish two main results: first, markets can improve upon the optimal dynamic contract at the presence of private information. Market prices fully reveal the aggregate states and help solve the incentive problem of the bank. Secondly, it is optimal for the bank to require loans be settled with short-term inside money, i.e., bank money that expires immediately after the settlement of debts. Short-term inside money makes it less costly to induce truthful revelation and achieve more efficient risk sharing.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1146.pdf
File Function: First version 2007
Download Restriction: no

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1146.

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Length: 43 pages
Date of creation: Dec 2007
Date of revision:
Handle: RePEc:qed:wpaper:1146
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Web page: http://qed.econ.queensu.ca/
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  1. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
  2. S. Rao Aiyagari & Stephen D. Williamson, 1998. "Money and Dynamic Credit Arrangements with Private Information," Game Theory and Information 9802002, EconWPA.
  3. James Bullard & Bruce D. Smith, 2001. "The value of inside and outside money," Working Papers 2000-027, Federal Reserve Bank of St. Louis.
  4. Miquel Faig, 2006. "Divisible Money In An Economy With Villages," Working Papers tecipa-216, University of Toronto, Department of Economics.
  5. Stephen Williamson, 2004. "Limited participation, private money, and credit in a spatial model of money," Economic Theory, Springer, vol. 24(4), pages 857-875, November.
  6. Shouyong Shi, 1995. "Credit and Money in a Search Model with Divisible Commodities," Working Papers 917, Queen's University, Department of Economics.
  7. Sun, Hongfei, 2007. "Aggregate uncertainty, money and banking," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1929-1948, October.
  8. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
  9. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
  10. David Andolfatto & Ed Nosal, 2003. "A Theory of Money and Banking," Macroeconomics 0310003, EconWPA.
  11. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  12. David Andolfatto & Ed Nosal, 2001. "A simple model of money and banking," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 20-28.
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