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Working Paper
Should Central Banks Issue Digital Currency?
We study how the introduction of a central bank-issued digital currency affects interest rates, the level of economic activity, and welfare in an environment where both central bank money and private bank deposits are used in exchange. Banks in our model are financially constrained, and the liquidity premium on bank deposits affects the level of aggregate investment. We study the optimal design of a digital currency in this setting, including whether it should pay interest and how widely it should circulate. We highlight an important policy tradeoff: while a digital currency tends to promote ...
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Superseded by Working Paper 15-20.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
Banking panics and protracted recessions
This paper develops a dynamic theory of money and banking that explains why banks need to hold an illiquid portfolio to provide socially optimal transaction and liquidity services, opening the door to the possibility of equilibrium banking panics. Following a widespread liquidation of banking assets in the event of a panic, the banking portfolio consistent with the optimal provision of transaction and liquidity services during normal times cannot be quickly reestablished, resulting in an unusual loss of wealth for all depositors. This negative wealth effect stemming from the liquid portion of ...
Journal Article
Bitcoin vs. the Buck: Is Currency Competition a Good Thing?
Ever since the U.S. established a single currency in the 19th century, the idea of private money has evoked panics and bank failures. In the cryptocurrency era, can the dollar stay sound?
Journal Article
New Moneys in the Digital Era
The history of money helps explain the recent turmoil in cryptocurrencies.
Working Paper
Private liquidity and banking regulation
The authors show that the regulation of bank lending practices is necessary for the optimal provision of private liquidity. In an environment in which bankers cannot commit to repay their creditors, the authors show that neither an unregulated banking system nor narrow banking can provide the socially efficient amount of liquidity. If the bankers provided such an amount, then they would prefer to default on their liabilities. The authors show that a regulation that increases the value of the banking sector?s assets (e.g., by limiting competition in bank lending) will mitigate the commitment ...
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 ...
Working Paper
A dynamic model of unsecured credit
The author studies the terms of credit in a competitive market in which sellers (lenders) are willing to repeatedly finance the purchases of buyers (borrowers) by engaging in a credit relationship. The key frictions are: (i) the lender is unable to observe the borrower's ability to repay a loan; (ii) the borrower cannot commit to any long-term contract; (iii) it is costly for the lender to contact a borrower and to walk away from a contract; and (iv) transactions within each credit relationship are not publicly observable. The lender's optimal contract has two key properties: delayed ...
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 ...