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Self-fulfilling runs and endogenous liquidity creation

David Rivero Leiva and Hugo Rodriguez Mendizabal

Journal of Financial Stability, 2019, vol. 45, issue C

Abstract: This paper incorporates endogenous money creation into the liquidity mismatch problem of Diamond and Dybvig (1983). We characterize a nominal economy where demandable deposits are created through lending. Depositors use sight deposits to buy consumption goods and the banks manage reserves to clear payments and to offset liquidity risk. We show that deposit contracts are suboptimal in terms of liquidity risk-sharing. We also observe that self-fulfilling runs depend on the refinancing rate of the central bank. Our analysis emphasizes the importance of effective lender of last resort policies to prevent expectational banking panics.

Keywords: Bank runs; Inside money; Risk-sharing (search for similar items in EconPapers)
JEL-codes: E42 G21 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:45:y:2019:i:c:s1572308919306552

DOI: 10.1016/j.jfs.2019.100704

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