Working Paper: CEPR ID: DP15827
Authors: Diemo Dietrich; Thomas Gehrig
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: expenditure needs; investment opportunities; liquidity; insurance; penalty rates; competitive bank business models
JEL Codes: D11; D86; E21; E22; G21; L22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| the coexistence of finvestors and pinvestors (G24) | bank liquidity creation (E51) |
| finvestors' preference for flexibility (G11) | bank liquidity creation (E51) |
| pinvestors' priority for precaution (G11) | bank liquidity creation (E51) |
| the presence of financial frictions (G19) | welfare losses (D69) |
| the extent of credit frictions (E51) | equilibrium outcomes (D51) |
| the coexistence of liquidity motives (E41) | inefficiencies and welfare losses (D61) |