Speculative and Precautionary Demand for Liquidity in Competitive Banking Markets

64 Pages Posted: 1 Mar 2021 Last revised: 27 May 2022

See all articles by Diemo Dietrich

Diemo Dietrich

University of Greifswald - Department of Economics

Thomas Gehrig

University of Vienna

Date Written: February 2021

Abstract

In standard models a preference for liquidity arises because investors want to take precautions against sudden expenditure needs. We propose that investors may also want to preserve flexibility in case better investment opportunities arrive later. The co-existence of both investor types is crucial for the scope and limits of bank liquidity creation. Co-existence can entail welfare gains in a friction-free world. However, when standard financial frictions apply, co-existence can result in welfare losses relative to a world with only a single investor type. In either case, policy recommendations based only on a single motive for liquidity demand may be seriously misguided.

Keywords: competitive bank business models, expenditure needs, Investment opportunities, liquidity insurance, Penalty rates

JEL Classification: D11, D86, E21, E22, G21, L22

Suggested Citation

Dietrich, Diemo and Gehrig, Thomas, Speculative and Precautionary Demand for Liquidity in Competitive Banking Markets (February 2021). CEPR Discussion Paper No. DP15827, Available at SSRN: https://ssrn.com/abstract=3795210

Diemo Dietrich (Contact Author)

University of Greifswald - Department of Economics ( email )

Friedrich-Loeffler-Strasse 70
D-17487 Greifswald
Germany

Thomas Gehrig

University of Vienna ( email )

Oskar-Morgenstern-Platz 1
Vienna, A-1090
Austria

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