On Separation between Payment and Saving Instruments

Hajime Tomura

No 1813, Working Papers from Waseda University, Faculty of Political Science and Economics

Abstract: This paper presents a three-period model to analyze why central-bank notes, i.e., payment instruments, and bank deposits, i.e., saving instruments, must be separated from each other as is the case in the modern banking system. The model shows that credit creation by note-issuing commercial banks improves risk sharing in the economy, because private bank notes can serve as payment instruments backed by a diversified pool of commercial bills issued by payers. If there are sunk costs of production, however, this characteristic of private bank notes can cause a self-fulfilling mass refusal of private bank notes by payees. Commercial banks can reduce the amount of reserves necessary to prevent such a bank-note run if they set up a conduit that issues only payment instruments, which corresponds to the central bank. The model replicates short-term re-discounting of commercial bills by the central bank as the optimal policy endogenously.

Keywords: Bank notes; Credit creation; Trade credit; Central bank; Discount window; Bank run (search for similar items in EconPapers)
Pages: 49 pages
Date: 2019-01
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