Traditionally, aggregate liquidity shocks are modelled as exogenous events. Extending our previous work (Cao & Illing, 2008), this paper analyses the adequate policy response to endogenous systemic liquidity risk. We analyse the feedback between lender of last resort policy and incentives of...

This paper introduces agent heterogeneity, liquidity, and endogenous default to a DSGE framework. Our model allows for a comprehensive assessment of regulatory and monetary policy, as well as welfare analysis in the different sectors of the economy. Due to liquidity and endogenous default, the...

This paper studies banks' liquidity provision in the Lagos and Wright model of monetary exchanges. With aggregate uncertainty we show that banks sometimes exhaust their cash reserves and fail to satisfy their depositors' need of consumption smoothing. The banking panics can be eliminated by the...

This paper studies the role of a lender of last resort (LLR) in a monetary model where a shortage of bank's monetary reserves (or a banking panic) occurs endogenously. We show that while a discount window policy introduced by the LLR is welfare improving, it reduces the banks' ex ante incentive...

This paper studies the role of a lender of last resort (LLR) in a monetary model where a shortage of a bank's monetary reserves (a liquidity crisis) occurs endogenously. We show that discount window lending by the LLR is welfare-improving but reduces banks' ex-ante incentive to hold monetary...

We analyze the similarities and the differences in the fragility of the European Monetary system (EMS) and the Eurozone. We test the hypothesis that in the EMS the fragility arose from the absence of a credible lender of last resort in the foreign exchange markets while in the Eurozone it was...

When agents are liquidity constrained, two options exist - sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government (outside) bonds and in the other they can borrow by issuing (inside) bonds. All transactions are voluntary, implying no...

Monetary policy is superneutral in an overlapping generations model. Previous authors have argued that superneutrality does not hold in such a setting. However, the standard results rely on the counter-factual premise of helicopter money and are overturned if money creation through open market...

We study money creation and destruction in today's monetary architecture within a general equilibrium setting. Two types of money are created and destructed: bank deposits, when banks grant loans to firms or to other banks, and central bank money, when the central bank grants loans to private...