Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously

Bank investments

Search-theoretic models of international currency - commentary

Money ; International finance

A dictum for monetary theory

A dictum for monetary theory; This essay argues that monetary theories should not contain an undefined object labeled money. Among existing theories that do not satisfy that dictum are models which assume that real balances are arguments of utility or production functions and models which assume cash-in-advance constraints. A main weakness of theories that do not satisfy the dictum is that they cannot address questions about which objects constitute money. Theories that do satisfy the dictum are those which specify assets by their physical properties and which permit the assets_ role in exchange to be endogenous. The essay briefly describes one such theory, a random matching model with assets that differ according to whether they throw off real dividends. This essay is reprinted, with permission, from the book Foundations of Research in Economics: How Do Economists Do Economics? (ed. Steven Medema and Warren Samuels), Cheltenham, U.K.: Edward Elgar Publishing, 1996.Monetary theory

S. Rao Aiyagari: my student and my teacher

This essay briefly reviews the professional life and work of economist S. Rao Aiyagari, who died after a heart attack on May 20, 1997, at the age of 45. Aiyagari is described as “one of the ablest economists of his generation.” The essay is accompanied by a complete list of Aiyagari’s published work and reprints of three of his articles in the Federal Reserve Bank of Minneapolis Quarterly Review: “Deflating the Case for Zero Inflation” (Summer 1990), “On the Contribution of Technology Shocks to Business Cycles” (Winter 1994), and “Macroeconomics With Frictions” (Summer 1994).Economists

Modeling Small Change: A Review Article

In The Big Problem of Small Change, Sargent and Velde apply a cash-in-advance model to the history of coinage and to contemporary thought about coinage. They assert that their model accounts for puzzling observations involving the depreciation and disappearance of small coins. I question its usefulness for that purpose and for other issues pertaining to coinage. My main concern is that their model does not depict the problems usually associated with full-bodied coinage systems-problems that stem from the technological difficulties of having a full-bodied coinage system in which money is portable, divisible, durable, and recognizable.

Absence-of-double-coincidence models of money: a progress report

This study describes a model built on the long-held view that the use of money as a medium of exchange is the result of an absence of double coincidence of wants. The model can account for two of the most challenging observations facing monetary theory: The disparate short-run and long-run effects of changes in the quantity of money and the coexistence of money and assets with higher rates of return. For both observations, the model's ability to provide a rich analysis depends on little more than the ingredients implicit in the absence-of-double-coincidence view.Money theory

Knowledge of individual histories and optimal payment arrangements.

This article reviews recent work that generalizes a random matching model of money to permit there to be a mix of transactions: some accomplished through the use of tangible media of exchange and the rest through some form of credit. The generalizations are accomplished by specifying assumptions about common knowledge of individual histories that are intermediate between no common knowledge and complete common knowledge. One of the specifications permits a simple representation of the sense in which more common knowledge is beneficial. The other permits a comparison between using outside money and using inside money as a medium of exchange.Money ; Credit

A banking model in which partial suspension is best

This paper establishes that partial suspension is an optimal arrangement in an aggregate-risk version of the Diamond-Dybvig (1983) model. The model is a variant of Wallace (1988) in which aggregate risk about the fraction of agents who "want to" consume early is limited to a small group who show up last to possibly withdraw early. Partial suspension means that when they do withdraw early, members of this group get less than those who showed up first to withdraw early. Limiting the aggregate risk to a group who show up last is a simplifying assumption because it makes it impossible to draw inferences about the aggregate state from the actions of those who show up first.Deposit insurance ; Bank failures

Narrow banking meets the Diamond-Dybvig model

A version of the Diamond-Dybvig model of banking is used to evaluate the narrow banking proposal, the idea that banks should be required to back demand deposits entirely by safe short-term assets. It is shown that the mere existence of an amount of safe short-term assets outside the banking system that exceeds banking system liabilities does not make the proposal either innocuous or desirable. In fact, despite such existence, using narrow banking to cope with banking system illiquidity eliminates the role of the banking system.Bank reserves