Credit Circulation, Bank Liquidity and Steady-State Non-Neutrality

Abstract

This paper shows that nominal operations move banks' lending rates in steady states by impacting their liquidity constraints, without frictions previously considered, e.g. nominal rigidity and search frictions. Moreover, the effects are heterogeneous. When bank credit is used to make purchase, it circulates from the buyer's bank into the seller's. Thus, each bank sees a fraction of its credit flows out into other banks. Expansionary policies reduce the lending rates of banks with the lowest outflow fractions, but, contrary to expectations, raise the rates of those with the highest. Lastly, if technology advancement eliminates depositor withdrawals, fiat money will stop circulating.

Keywords: Bank liquidity, non-neutrality, bank credit circulation, outflow fraction, heterogeneous effects

JEL Classification: E50, G21