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 ...
Unemployment and economic welfare
Statistics that measure labor market activity are often interpreted as measures of economic performance and social well being. This article demonstrates that such interpretations are not justified in the absence of information concerning the economic circumstances that determine individual labor market choices.
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 ...
Bank Runs without Sequential Service
Banking models in the tradition of Diamond and Dybvig (1983) rely on sequential service to explain belief-driven runs. But the run-like phenomena witnessed during the financial crisis of 2007?08 occurred in the wholesale shadow banking sector where sequential service is largely absent, suggesting that something other than sequential service is needed to help explain runs. We show that in the absence of sequential service runs can easily occur whenever bank-funded investments are subject to increasing returns to scale consistent with available evidence. Our framework is used to understand and ...
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 ...
Monetary policy regimes and beliefs
Revised. This paper investigates the role of beliefs over monetary policy in propagating the effects of monetary policy shocks within the context of a dynamic, stochastic general equilibrium model. In this model, monetary policy periodically switches between low- and high-money-growth regimes. When individuals cannot observe the regime directly, they must draw inferences over regime type based on historical money growth rates. The authors show that for an empirically plausible money growth process, beliefs evolve slowly in the wake of a regime change. As a result, their model is able to ...
A theory of money and banking
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 ...
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.
Essential interest-bearing money
I examine optimal monetary policy in a Lagos and Wright [A unified framework for monetary theory and policy analysis, J. Polit. Econ. 113 (2005) 463?484] model where trade is centralized and all exchange is voluntary. I identify a class of incentive feasible policies that improve welfare beyond what is achievable with zero intervention. Any policy in this class necessarily entails a non-negative inflation rate and a strictly positive nominal interest rate. Despite the absence of a lump-sum tax instrument, there exists an incentive-feasible policy that implements the first-best allocation.
Monetary policy with asset-backed money
We study the use of intermediated assets as media of exchange in a neo- classical growth model. An intermediary is delegated control over productive capital and finances itself by issuing claims against the revenue generated by its operations. Unlike physical capital, intermediated claims are assumed to be liquid-they constitute a form of asset-backed money. The intermediary is assumed to control 1) the number of claims outstanding, 2) the dividends paid out to claim holders and 3) the fee charged for collecting the dividend. We find that for patient economies, the first-best allocation can ...