Liquidity, Banking, and Bank Failures

Stephen Williamson

International Economic Review, 1988, vol. 29, issue 1, 25-43

Abstract: A multiperiod model with risk-neutral agents is constructed in which a liquidity problem arises in an equilibrium with decentralized tradin g in capital, which banking institutions are able to alleviate. Depos it contracts provide for early withdrawal, banks hold debt, and agent s who borrow from banks hold compensating balances. Institutional col lapse, or a state of the world when bank failures are experienced, is associated with a high demand for liquidity, low output, and a lower than average level of welfare. Bank failure is symptomatic of a part icular state of endowments, preferences, and technology, and governme nt intervention is undesirable. Copyright 1988 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 1988
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