Pierpaolo Benigno (LUISS, Rome and EIEF)
Pierpaolo Benigno (LUISS and EIEF) — Roberto Robatto (University of Wisconsin-Madison)
We study the joint supply of public and private liquidity using a simple macroeconomic model. In a frictionless, competitive financial market, private intermediaries create riskless securities (safe assets) and the economy achieves the first best. If instead equity is more costly than debt, a pecuniary externality arises, financial intermediaries supply risky securities, and the economy is vulnerable to liquidity crunches. We use our framework to revisit, in the context of the modern financial system, some classic proposals on liquidity supply (real-bills doctrine, free banking, narrow banking), comparing them with recent interventions (asset purchases, government guarantees of intermediaries' debt, bailouts).