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Working Paper
Preventing Bank Runs
Diamond and Dybvig (1983) is commonly understood as providing a formal rationale for the existence of bank-run equilibria. It has never been clear, however, whether bank-run equilibria in this framework are a natural byproduct of the economic environment or an artifact of suboptimal contractual arrangements. In the class of direct mechanisms, Peck and Shell (2003) demonstrate that bank-run equilibria can exist under an optimal contractual arrangement. The difficulty of preventing runs within this class of mechanism is that banks cannot identify whether withdrawals are being driven by ...
Working Paper
The role of independence in the Green-Lin Diamond-Dybvig model
Green and Lin study a version of the Diamond-Dybvig model with a finite number of agents, independence (independent determination of each agent?s type), and sequential service. For special preferences, they show that the ex ante first-best allocation is the unique equilibrium outcome of the model with private information about types. Via a simple argument, it is shown that uniqueness of the truth-telling equilibrium holds for general preferences, and, in particular, for a constrained-efficient allocation whether first-best or not. The crucial assumption is independence.
Working Paper
Moral hazard in the Diamond-Dybvig model of banking
We modify the Diamond-Dybvig model studied in Green and Lin to incorporate a self-interested banker who has a private record-keeping technology. A public record-keeping device does not exist. We find that there is a trade-off between sophisticated contracts that possess relatively good risk-sharing properties but allocate resources inefficiently for incentive reasons, and simple contracts that possess relatively poor risk-sharing properties but economize on the inefficient use of resources. While this trade-off depends on model parameters, we find that simple contracts prevail under a wide ...
Journal Article
On the Supply of, and Demand for, U.S. Treasury Debt
Throughout the early 2000s, federal debt held by the public?the amount of outstanding U.S. Treasury securities (Treasuries) held by the Federal Reserve System and private investors?was stable at around 35 percent of gross domestic product (GDP).
Working Paper
Bank Panics and Scale Economies
A bank panic is an expectation-driven redemption event that results in a self-fulfilling prophecy of losses on demand deposits. From the standpoint of theory in the tradition of Diamond and Dybvig (1983) and Green and Lin (2003), it is surprisingly di cult to generate bank panic equilibria if one allows for a plausible degree of contractual flexibility. A common assumption employed in the standard banking model is that returns are linear in the scale of investment. Instead, we assume the existence of a fixed investment cost, so that a higher risk-adjusted rate of return is available only if ...
Journal Article
Liquidity shocks, real interest rates, and global imbalances
The author uses a simple neoclassical model to show how liquidity shocks at home and abroad can contribute to trade imbalances and low real interest rates. The author?s interpretation is consistent with Bernanke?s (2005) ?global saving glut? hypothesis.
Journal Article
A simple model of money and banking
This article presents a simple environment that has banks creating and lending out money. The authors define money to be any object that circulates widely as a means of payment and a bank to be an agency that simultaneously issues money and monitors investments. While their framework allows private nonbank liabilities to serve as the economy's medium of exchange, they demonstrate that the cost-minimizing structure has a bank creating liquid funds. In practice, the vast bulk of the money supply consists of private debt instruments that are issued by banks. Thus, their model goes some way in ...
Working Paper
Rehypothecation and Liquidity
We develop a dynamic general equilibrium monetary model where a shortage of collateral and incomplete markets motivate the formation of credit relationships and the rehypothecation of assets. Rehypothecation improves resource allocation because it permits liquidity to flow where it is most needed. The liquidity benefits associated with rehypothecation are shown to be more important in high-inflation (high interest rate) regimes. Regulations restricting the practice are shown to have very different consequences depending on how they are designed. Assigning collateral to segregated accounts, as ...
Hot Money Credits to Kick-Start a Stalled Economy?
Stimulus checks that must be spent within a certain amount of time could help trigger spending if the economy continues to stall.