Private and Public Supply of Liquidity

46 Pages Posted: 20 Sep 2000 Last revised: 28 May 2008

See all articles by Bengt R. Holmström

Bengt R. Holmström

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Jean Tirole

University of Toulouse 1 - Industrial Economic Institute (IDEI); University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1996

Abstract

This paper addresses a basic yet unresolved question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the State have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means? In our model, firms can meet future liquidity needs in three ways: by issuing new claims and diluting old ones, by obtaining a credit credit line from a financial intermediary, and by holding claims on other firms. When there is no aggregate uncertainty, we show that these instruments are sufficient for attaining the socially optimal (second-best) contract between investors and firms. Such a contract imposes both a maximum leverage ratio and a liquidity constraint on firms. Intermediaries coordinate the use of liquidity. Without intermediation, scarce liquidity may be wasted and the social optimum may not be attainable. When there is only aggregate uncertainty the private sector is no longer self-sufficient with regard to liquidity. The government can improve liquidity by issuing bonds that commit future consumer income. Government bonds command a liquidity premium over private claims. The supply of liquidity can be managed by loosening liquidity (boosting the value of its securities) when the aggregate liquidity shock is high and tightening liquidity when the shock is low. The paper thus provides a microeconomic example of government supplied liquidity as well as of the possibility of active government policy.

Suggested Citation

Holmström, Bengt R. and Tirole, Jean, Private and Public Supply of Liquidity (November 1996). NBER Working Paper No. w5817, Available at SSRN: https://ssrn.com/abstract=225605

Bengt R. Holmström (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Bldg. E52-271d
Cambridge, MA 02142
United States
617-253-0506 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Jean Tirole

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

Place Anatole France
21 Allees de Brienne
F-31042 Toulouse Cedex
France
+33 5 61 12 8642 (Phone)
+33 5 61 12 8637 (Fax)

University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ) ( email )

Manufacture des Tabacs
21 Allees de Brienne
Toulouse, 31000
France

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
331
Abstract Views
5,451
rank
99,411
PlumX Metrics