Creator: Smith, Bruce D. (Bruce David), 1954-2002 Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 258 Abstract:
Recent developments in the theory of economies with private information permit a re-examination of the issues raised in the "real bills-quantity theory" debate. A model is developed here in which there are banks, in which fiat money is present, and in which agents possess private information. Two regulatory regimes are then considered. In the first, banks are essentially unregulated. In the second, banks face 100 percent reserve requirements. Issues related to existence and optimality of equilibrium are addressed, and problems with existence are given an interpretation in terms of the "stability" of the banking system. Existence (stability) problems which arise under laissez-faire banking can be rectified by a 100 percent reserve requirement. However, unless there is private information regarding access to investment opportunities, there are typically better ways to accomplish this. Finally, it is shown that even in the presence of 100 percent reserve requirements banks are not simply "money warehouses." Bank deposits and money bear different (real) return streams, even under 100 percent reserves.
Keyword: Fiat money, Financial intermediaries, Regulation, Equilibrium, Real bills-quantity theory, and Bank Subject (JEL): D82 - Asymmetric and Private Information; Mechanism Design and G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages