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Banking crises and liquidity in a monetary economy

Tarishi Matsuoka and Makoto Watanabe

Journal of Economic Dynamics and Control, 2019, vol. 108, issue C

Abstract: This study investigates banks’ liquidity provision using the Lagos and Wright model of monetary exchange. With aggregate uncertainty, we show that banks sometimes exhaust their cash reserves and fail to satisfy their depositors’ needs for consumption smoothing. We also show that banking crises can be eliminated by a rate-of-return-equalizing policy under perfect risk sharing, but the first-best outcome can be only achieved with the Friedman rule. These results cannot be obtained with other monetary models (e.g., overlapping generations models). We also derive a rich array of non-trivial effects of inflation on equilibrium deposits, the probability of banking crises, and banks’ portfolios.

Keywords: Money search; Monetary equilibrium; Banking crisis; Liquidity (search for similar items in EconPapers)
JEL-codes: E40 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1016/j.jedc.2019.103724

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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