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Working Paper
A Dynamic Model of Intermediated Consumer Credit and Liquidity
We construct a model of consumer credit with payment frictions, such as spatial separation and unsynchronized trading patterns, to study optimal monetary policy across different interbank market structures. In our framework, intermediaries play an essential role in the functioning of the payment system, and monetary policy influences the equilibrium allocation through the interest rate on reserves. If interbank credit markets are incomplete, then monetary policy plays a crucial role in the smooth operation of the payment system. Specifically, an equilibrium in which privately issued debt ...
Working Paper
Can currency competition work?
Can competition work among privately issued fiat currencies such as Bitcoin or Ethereum? Only sometimes. To show this, we build a model of competition among privately issued fiat currencies. We modify the current workhorse of monetary economics, the Lagos-Wright environment, by including entrepreneurs who can issue their own fiat currencies in order to maximize their utility. Otherwise, the model is standard. We show that there exists an equilibrium in which price stability is consistent with competing private monies but also that there exists a continuum of equilibrium trajectories with the ...
Working Paper
Banking crises and the role of bank coalitions
The goal of this paper is to provide a framework to analyze the effectiveness of bank coalition formation in response to an external aggregate shock that may cause disruption to the payment mechanism and real economic activity. I show that the kind of insurance mechanism provided by a specific type of bank coalition allows society to completely prevent any disruption to real activity that can be caused by a temporary drop in the value of banking assets, at least in the case of a shock that is not too big. If the shock is relatively large, then a private bank coalition will be unable to ...
Working Paper
On the welfare properties of fractional reserve banking
Superseded by Working Paper 15-20. Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long-term) investment opportunities, and the difficulties associated with fractional reserve banking, such as the risk of insolvency for each bank. The goal of this paper is to show that a specific form of private bank coalition (a joint-liability arrangement) allows the members of the banking system to engage in fractional reserve banking in such a way that the solvency of each member bank is completely ...
Working Paper
On the inherent instability of private money
Superseded by Working Paper 15-18. We show the existence of an inherent instability associated with a purely private monetary system due to the role of endogenous debt limits in the creation of private money. Because the bankers? ability to issue liabilities that circulate as a medium of exchange depends on beliefs about future credit conditions, there can be multiple equilibria. Some of these equilibria have undesirable properties: Self-fulfilling collapses of the banking system and persistent fluctuations in the aggregate supply of bank liabilities are possible. In response to this inherent ...
Working Paper
International Currency Dominance
We present a micro-founded monetary model of the world economy to study international currency competition. Our model features both “unipolar” equilibria, with a single dominant international currency, and “multipolar” equilibria, in which multiple currencies circulate internationally. Long-run equilibria are highly history-dependent and tend towards the emergence of a dominant currency. Governments can compete to internationalize their currencies by offering attractive interest rates on their sovereign debt, but large economies have a natural advantage in ensuring the dominance of ...
Working Paper
On the inherent instability of private money
A primary concern in monetary economics is whether a purely private monetary regime is consistent with macroeconomic stability. I show that a competitive regime is inherently unstable due to the properties of endogenously determined limits on private money creation. Precisely, there is a continuum of equilibria characterized by a self-fulfilling collapse of the value of private money and a persistent decline in the demand for money. I associate these equilibrium allocations with self-fulfilling banking crises. It is possible to formulate a fiscal intervention that results in the global ...
Working Paper
Optimal monetary policy in a model of money and credit
The authors study optimal monetary policy in a model in which fiat money and private debt coexist as a means of payment. The credit system is endogenous and allows buyers to relax their cash constraints. However, it is costly for agents to publicly report their trades, which is necessary for the enforcement of private liabilities. If it is too costly for the government to obtain information regarding private transactions, then it relies on the public information generated by the private credit system. If not all private transactions are publicly reported, the government has imperfect public ...
Working Paper
On the Economics of Digital Currencies
Can a monetary system in which privately issued cryptocurrencies circulate as media of exchange work? Is such a system stable? How should governments react to digital currencies? Can these currencies and government-issued money coexist? Are cryptocurrencies consistent with an efficient allocation? These are some of the important questions that the sudden rise of cryptocurrencies has brought to contemporary policy discussions. To answer these questions, we construct a model of competition among privately issued .at currencies. We .nd that a purely private arrangement fails to implement an ...
Working Paper
Financial Instability with Circulating Debt Claims and Endogenous Debt Limits
This paper develops a banking model in which intermediaries issue liabilities that circulate as a medium of exchange to finance loans to entrepreneurs, who use the proceeds to fund the accumulation of capital goods. The issuance of circulating liabilities, together with endogenous debt limits, gives rise to a franchise value for intermediaries. A competitive equilibrium with endogenous debt limits admits allocations that are characterized by a funding crisis and a self-fulfilling collapse of the banking system, with the intermediary’s franchise value eroding over time. In view of these ...