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A theory of money and banking

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Abstract

The authors construct a simple environment that combines a limited communication friction and a limited information friction in order to generate a role for money and intermediation. They ask whether there is any reason to expect the emergence of a banking sector (i.e., institutions that combine the business of money creation with the business of intermediation). In their model, the unique equilibrium is characterized partly by the existence of an agent that: (1) creates money (a debt instrument that circulates as a means of payment); (2) lends it out (swapping it for less liquid forms of debt); (3) is responsible for monitoring those agents in control of the capital backing the illiquid debt; and (4) collects on money loans as they come due.

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  • David Andolfatto & Ed Nosal, 2003. "A theory of money and banking," Working Papers (Old Series) 0310, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:0310
    DOI: 10.26509/frbc-wp-200310
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    References listed on IDEAS

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    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    2. David Andolfatto & Ed Nosal, 2001. "A simple model of money and banking," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 20-28.
    3. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
    4. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
    5. Bullard, James & Smith, Bruce D., 2003. "Intermediaries and payments instruments," Journal of Economic Theory, Elsevier, vol. 109(2), pages 172-197, April.
    6. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
    7. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 12(Fall), pages 3-16.
    8. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    9. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, May.
    10. Ricardo O. Cavalcanti, 2004. "A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 24(4), pages 769-788, November.
    11. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "A model of private bank-note issue," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 104-136, January.
    12. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 647-663.
    13. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
    14. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-971, December.
    15. Krasa, Stefan & Villamil, Anne P, 1992. "A Theory of Optimal Bank Size," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 725-749, October.
    16. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
    17. David E. Laidler, 1988. "Taking Money Seriously," Canadian Journal of Economics, Canadian Economics Association, vol. 21(4), pages 687-713, November.
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    Cited by:

    1. Wen, Yi, 2015. "Money, liquidity and welfare," European Economic Review, Elsevier, vol. 76(C), pages 1-24.
    2. COCIUG, Victoria & TIMOFEI, Olga, 2016. "Optimization Of Monetary Creation By Linking Monetary Policies With Commercial Banks' Strategies," Studii Financiare (Financial Studies), Centre of Financial and Monetary Research "Victor Slavescu", vol. 20(2), pages 79-90.
    3. Sun, Hongfei, 2007. "Aggregate uncertainty, money and banking," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1929-1948, October.
    4. Yi Wen, 2012. "Liquidity and welfare," Working Papers 2012-037, Federal Reserve Bank of St. Louis.
    5. Chiu, Jonathan & Meh, Césaire A., 2011. "Financial Intermediation, Liquidity, And Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 83-118, April.
    6. He, Ping & Huang, Lixin & Wright, Randall, 2008. "Money, banking, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1013-1024, September.
    7. Diarmid Weir, 2013. "Fiat Money, Individual Rationality and Production," Metroeconomica, Wiley Blackwell, vol. 64(4), pages 573-590, November.
    8. COCIUG, Victoria & TIMOFEI, Olga, 2014. "Monetary Policy Force Effect By Means Of Banks Money Creation," Studii Financiare (Financial Studies), Centre of Financial and Monetary Research "Victor Slavescu", vol. 18(2), pages 18-28.
    9. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
    10. Sun, Hongfei, 2007. "Banking, Inside Money and Outside Money," MPRA Paper 4504, University Library of Munich, Germany.
    11. Geoffrey Dunbar, 2005. "International Lending, Capital Controls and Wealth Inequality," 2005 Meeting Papers 492, Society for Economic Dynamics.

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    Keywords

    Money; Banks and banking; Information theory;
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    1. Advanced Monetary Theory and Policy (ECON 447)

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