Banking with Inside Money: An Efficiency Analysis

Key Points

• This research examines how effectively banks supply liquidity in an economy using inside money and the role of central banks in improving welfare.
• Analyzed a nominal Diamond-Dybvig economy model with inside money.
• Evaluated state-contingent deposit contracts and their impact on consumption possibilities.
• Assessed the potential of unconventional monetary policy by central banks.
• Banks fail to decentralize the first best in liquidity supply under inside money.
• State-contingent deposit contracts do not expand consumption possibilities as expected.
• Unconventional monetary policy by central banks improves welfare for savers, and they can mitigate bank runs.

Abstract