This paper incorporates endogenous money creation into the liquidity mismatch problem
of Diamond and Dybvig (1983). We characterize a nominal economy where demandable
deposits are created through lending. Depositors use sight deposits to buy consumption
goods and the banks manage reserves to clear payments and to offset liquidity risk. We
show that deposit contracts are suboptimal in terms of liquidity risk-sharing. We also
observe that the self-fulfilling run depends on the refinancing rate ...
This paper incorporates endogenous money creation into the liquidity mismatch problem
of Diamond and Dybvig (1983). We characterize a nominal economy where demandable
deposits are created through lending. Depositors use sight deposits to buy consumption
goods and the banks manage reserves to clear payments and to offset liquidity risk. We
show that deposit contracts are suboptimal in terms of liquidity risk-sharing. We also
observe that the self-fulfilling run depends on the refinancing rate of the central bank. Our
analysis emphasizes the importance of effective lender of last resort policies to prevent
expectational banking panics.
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