Money, Financial Stability and Efficiency

Douglas Gale (), Franklin Allen and Elena Carletti ()

No 8553, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Most analyses of banking crises assume that banks use real contracts. However, in practice contracts are nominal and this is what is assumed here. We consider a standard banking model with aggregate return risk, aggregate liquidity risk and idiosyncratic liquidity shocks. We show that, with non-contingent nominal deposit contracts, the first-best efficient allocation can be achieved in a decentralized banking system. What is required is that the central bank accommodates the demands of the private sector for fiat money. Variations in the price level allow full sharing of aggregate risks. An interbank market allows the sharing of idiosyncratic liquidity risk. In contrast, idiosyncratic (bank-specific) return risks cannot be shared using monetary policy alone; real transfers are needed.

Keywords: Monetary policy; Nominal contracts (search for similar items in EconPapers)
JEL-codes: E42 E44 E52 E58 (search for similar items in EconPapers)
Date: 2011-09
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Money, financial stability and efficiency (2014)
Working Paper: Money, Financial Stability and Efficiency (2012)
Working Paper: Money, Financial Stability and Efficiency (2011)
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