Liquidity and the Allocation of Credit: Business Cycle, Government Debt and Financial Arrangements

54 Pages Posted: 29 Jun 2005

See all articles by Filippo Taddei

Filippo Taddei

School of Advanced International Studies (SAIS) - The Johns Hopkins University

Date Written: November 2004

Abstract

I analyze the equilibrium level of liquidity and its relevance for the allocation of credit across different technologies, when the notion of liquidity is related to private information. The general equilibrium analysis yields the following main implications: firstly, it provides an explanation of procyclical liquidity even in the presence of security endogeneity; secondly, it illustrates how government debt, by providing liquidity to an otherwise illiquid private market, encourages rather than crowds out private investment; thirdly, there is a well defined notion of collateral - the root of securities' value - the liquidity of which is endogenously enhanced by the arrangements within financial markets.

The approach is integrated because it jointly analyzes the three factors crucial to liquidity: (1) its level is endogenously determined through equilibrium pricing while entrepreneurs choose which security to issue; (2) the introduction of government debt has the two-fold effect of directly providing liquidity to entrepreneurs and indirectly influencing the kind of securities they issue in equilibrium; (3) financial markets develop arrangements to allow the beneficial employment of securities, not only physical assets, as collateral (financial pyramiding).

Keywords: Liquidity, endogenous securities, government debt, financial pyramiding

JEL Classification: E22, E32, E62, G14, G32

Suggested Citation

Taddei, Filippo, Liquidity and the Allocation of Credit: Business Cycle, Government Debt and Financial Arrangements (November 2004). Available at SSRN: https://ssrn.com/abstract=752964 or http://dx.doi.org/10.2139/ssrn.752964

Filippo Taddei (Contact Author)

School of Advanced International Studies (SAIS) - The Johns Hopkins University ( email )

via Andreatta, 3
Bologna, Bologna
Italy

HOME PAGE: http://https://www.sais-jhu.edu/filippo-taddei

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