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Journal Article
The optimum quantity of money
A central premise of monetary policy in the U.S. throughout the first decade of the 21st century has been a firm commitment to avoid deflation. Indeed, it is the consensus view of policymakers and most economists. Nonetheless, Nobel laureate Milton Friedman proposed that optimal monetary policy should lead to a steady rate of deflation. For some economists, the Friedman rule is mainly a benchmark for thinking clearly about the assumptions underlying our models and a systematic guide for deciding how to modify our models, that is, a way of making scientific progress. However, it is not an ...
Working Paper
Pairwise credit and the initial cost of lending
The author studies the terms of credit in a competitive market in which sellers are willing to repeatedly finance the purchases of buyers by extending direct credit. Lenders (sellers) can commit to deliver any long-term credit contract that does not result in a payoff that is lower than that associated with autarky, while borrowers (buyers) cannot commit to any contract. A borrower's ability to repay a loan is privately observable. As a result, the terms of credit within an enduring relationship change over time, according to the history of trades. Two borrowers are treated differently by the ...
Working Paper
Price-Level Determination Under the Gold Standard
We present a micro-founded monetary model of a small open economy to examine the behavior of money, prices, and output under the gold standard. In particular, we formally analyze Hume’s celebrated price-specie flow mechanism. Our framework incorporates the influence of international trade on the money supply in the Home country through gold flows. In the short run, a positive correlation exists between the quantity of money and the price level. Additionally, we demonstrate that money is non-neutral during the transition to the steady state, which has implications for welfare. While the gold ...
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Superseded by Working Paper 15-18.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
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
A Model of the Gold Standard
The gold standard emerged as the international monetary system by the end of the 19th century. We formally study its properties in a micro-founded model and find that the scarcity of the world gold stock not only results in a suboptimal output of goods that are purchased with money but also subjects the domestic economy of a country to external shocks. The creation of inside money in the form of private credit instruments adds to the money supply, usually resulting in a Pareto improvement, but opens the door to the international transmission of banking crises. These properties of the gold ...
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 ...
Working Paper
Banking Panics and Output Dynamics
This paper develops a dynamic general equilibrium model with an essential role for an illiquid banking system to investigate output dynamics in the event of a banking crisis. In particular, it considers the ex-post efficient policy response to a banking crisis as part of the dynamic equilibrium analysis. It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of the liquidation cost, the recession associated with a banking panic is protracted as a result of the premature ...
Journal Article
Central Bank Digital Currency: Is It a Good Idea?
A CBDC might make banking easier for you and me. It might also change how banks operate.
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 ...