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Excess liquidity and monetary overhangs

  • Caprio, Gerard
  • Honohan, Patrick

The term"excess liquidity"may refer to the share of liquid assets in bank portfolios (the result of a retrenchment in bank lending, or a"credit crunch") or to money holdings of the nonbank public. Excess liquidity may be voluntary or nonvoluntary. In response to excess liquidity, policymakers tend to take steps to drain off the excess so it will not lead to a surge in inflation. In this paper, the authors examine the appropriateness of conventional policy instruments for tightening money in two common cases: 1) when there is a voluntary credit crunch because of a rise in perceived risk of default, and 2) when individuals rationed in the goods market in reforming socialist economies accumulate savings involuntarily ("money overhang"). The authors conclude that neither excess liquidity in the banking systems of the developing world nor the money overhang of the reforming planned economies calls for a response of restrictive monetary policy. A more appropriate policy might be a prudent but not overly restrictive monetary policy and reservation of some part of credit for the emerging private sector.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 796.

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Date of creation: 31 Oct 1991
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Handle: RePEc:wbk:wbrwps:796
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  1. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  2. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
  3. Mark L. Gertler, 1988. "Financial Structure and Aggregate Economic Activity: An Overview," NBER Working Papers 2559, National Bureau of Economic Research, Inc.
  4. Barro, Robert J & Grossman, Herschel I, 1971. "A General Disequilibrium Model of Income and Employment," American Economic Review, American Economic Association, vol. 61(1), pages 82-93, March.
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