Money, Banking and Financial Markets
50 Pages Posted: 7 Sep 2017 Last revised: 27 Nov 2019
Date Written: 2017-08-03
The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997) model of banking and financial markets with the Lagos and Wright (2005) dynamic model of monetary exchangeâ€“a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable in government money, where the terms of bank deposit contracts are affected by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. Among other things, the model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.
Keywords: Federal Reserve Bank of St. Louis, Economic Research, Money, Banks, Financial markets, Lender-of-last-resort, Bank runs
JEL Classification: E44, E52, E58, G21
Suggested Citation: Suggested Citation