Inefficient Provision of Liquidity
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); University of Chicago - Polsky Center for Entrepreneurship; European Corporate Governance Institute (ECGI)
August 1, 2011
Chicago Booth Research Paper No. 11-27
We study an economy where the lack of a simultaneous double coincidence of wants creates the need for a relatively safe asset (money). We show that, even in the absence of asymmetric information or an agency problem, the private provision of liquidity is inefficient. The reason is that liquidity affects prices and the welfare of others, and creators do not internalize this. This distortion is present even if we introduce lending and government money. To eliminate the inefficiency the government must restrict the creation of liquidity by the private sector.
Number of Pages in PDF File: 39
Keywords: liquidity, money, banking
JEL Classification: E41 G21, E51
Date posted: August 1, 2011
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