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Interbank market and central bank policy
We develop a model in which financial intermediaries hold liquidity to protect themselves from shocks. Depending on parameter values, banks may choose to hold too much or too little liquidity on aggregate compared with the socially optimal amount. The model endogenously generates a situation of cash hoarding, leading to the associated market freezes or underinsurance against liquidity choice. The model therefore provides a unified framework for thinking, on the one hand, about policy measures that can reduce hoarding of cash by banks and, on the other hand, about liquidity requirements of the ...