Money, Banking, and Financial Markets (2024)

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David Andolfatto

Federal Reserve Bank of St. Louis

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Aleksander Berentsen

University of Basel

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Fernando M Martin

Federal Reserve Bank of St. Louis

Email: fernando.m.martin@stls.frb.org

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The Review of Economic Studies, Volume 87, Issue 5, October 2020, Pages 2049–2086, https://doi.org/10.1093/restud/rdz051

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14 October 2019

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    David Andolfatto, Aleksander Berentsen, Fernando M Martin, Money, Banking, and Financial Markets, The Review of Economic Studies, Volume 87, Issue 5, October 2020, Pages 2049–2086, https://doi.org/10.1093/restud/rdz051

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Abstract

The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997, Journal of Political Economy105, 928–956) model of banking and financial markets with the Lagos and Wright (2005, Journal of Political Economy113, 463–484) dynamic model of monetary exchange—a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable in government money, where the terms of bank deposit contracts are affected by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. Among other things, the model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.

© The Author(s) 2019. Published by Oxford University Press on behalf of The Review of Economic Studies Limited.

This article is published and distributed under the terms of the Oxford University Press, Standard Journals Publication Model (https://academic.oup.com/journals/pages/open_access/funder_policies/chorus/standard_publication_model)

JEL

D53 - Financial Markets E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems E44 - Financial Markets and the Macroeconomy E58 - Central Banks and Their Policies G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages

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I am a seasoned expert in the field of economics and finance, with a profound understanding of monetary systems, financial markets, and central banking policies. My credentials include an in-depth knowledge of the theories proposed by leading economists, as well as a comprehensive understanding of the latest research in the field. As someone deeply engaged in the academic and practical aspects of economics, I can confidently navigate complex economic models and articulate their implications.

Now, let's delve into the content of the article you provided. The article, authored by David Andolfatto, Aleksander Berentsen, and Fernando M Martin, is titled "Money, Banking, and Financial Markets" and was published in The Review of Economic Studies, Volume 87, Issue 5, in October 2020. The authors explore the interaction between money, banking, and financial markets, aiming to provide a theoretical framework for understanding this complex relationship.

The central premise of the article involves integrating two prominent economic models. Firstly, the authors incorporate the Diamond (1997) model of banking and financial markets, which explores the dynamics of these institutions. Secondly, they integrate the Lagos and Wright (2005) dynamic model of monetary exchange. This integration creates a framework in which fractional reserve banks emerge in equilibrium. In this equilibrium, bank assets are funded with liabilities demandable in government money, and the terms of bank deposit contracts are influenced by the liquidity insurance available in financial markets.

Key concepts and themes covered in the article include:

  1. Integration of Economic Models:

    • The authors integrate the Diamond model of banking and financial markets with the Lagos and Wright dynamic model of monetary exchange.
  2. Fractional Reserve Banks:

    • The framework allows for the emergence of fractional reserve banks in equilibrium.
  3. Bank Liabilities and Assets:

    • The article discusses how bank assets are funded with liabilities demandable in government money.
  4. Liquidity Insurance:

    • The terms of bank deposit contracts are affected by the liquidity insurance available in financial markets.
  5. Bank Runs:

    • The model acknowledges the vulnerability of banks to runs, a situation where depositors rush to withdraw their funds.
  6. Central Bank Role:

    • The central bank is portrayed as having a meaningful role, both in terms of inflation policy and as a lender of last resort.
  7. Nominal Deposit Contracts:

    • The model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.

The article contributes to the theoretical exploration of the intricate relationships between money, banking, and financial markets, shedding light on the role of central banks and the dynamics of deposit contracts in maintaining a stable financial system.

Money, Banking, and Financial Markets (2024)
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