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Liquidity, Efficiency and Bank Bailouts

  • Gary Gorton
  • Lixin Huang

Governments can efficiently provide liquidity, as when the banking system is bailed out. We study a model in which not all assets can be used to purchase all other assets at every date. Agents sometimes want to sell projects. The market price of the projects sold depends on the supply of liquidity, which is determined in general equilibrium. While private liquidity provision is socially beneficial since it allows valuable reallocations, it is also socially costly since liquidity suppliers could have made more efficient investments ex ante. There is a role for the government to supply liquidity by issuing government securities.

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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 02-33.

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Date of creation: Aug 2002
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Handle: RePEc:wop:pennin:02-33
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