Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/299375 
Year of Publication: 
2024
Series/Report no.: 
KOF Working Papers No. 516
Publisher: 
ETH Zurich, KOF Swiss Economic Institute, Zurich
Abstract: 
We introduce banks that issue liquid deposits backed by bonds and capital into an otherwise standard cash-in-advance economy. Liquidity transformation by banks increases aggregate consumption and investment relative to a cash-only economy but can also lead to inefficient overinvestment. Furthermore, liquidity transformation can lead to multiple steady-state equilibria with different interest rates and real outcomes. Whenever multiple equilibria exist, one of them constitutes a 'liquidity trap', in which nominal bond rates equal zero and banks are indifferent between holding bonds and reserves. Whether economic activity is higher in a liquidity trap or in a (coexisting) equilibrium with positive interest rates is ambiguous, but the liquidity trap equilibrium is more likely to go in hand with overinvestment.
Subjects: 
Banks
Liquidity
Monetary Policy
Zero-Lower Bound
JEL: 
E4
E5
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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