Discussion of “Banking in a Matching Model of Money and Capital”

Abstract

THE PAPER BY BENCIVENGA AND CAMERA (2011, this issue) studies how banks can improve the allocation of resources in an environment where trading frictions make money useful for certain types of exchange. Its starting point is the observation that the random nature of trading opportunities commonly used in modern monetary models is structurally similar to a type of liquidity-preference uncertainty that appears in the banking literature. It seems natural, therefore, to ask what insights can be gained by combining these separate strands of research. The paper presents a model of decentralized trade in which banks arise endogenously as an arrangement for efficiently distributing cash to agents when they have attractive buying opportunities. It then studies the relationship between inflation and the functioning of the banking system, as well as the effects of a central bank policy of paying interest on bank reserves. The paper is part of an important research agenda that aims to study financial institutions in general equilibrium models where money plays an explicit role. The model in the paper builds on that in Lagos and Wright (2005), where agents alternate between trading in centralized and decentralized markets and the information structure is such that decentralized trade requires the use of money. Agents can hold their wealth in either money or capital; capital typically offers a higher rate of return but cannot be used to purchase goods in decentralized trade. When making portfolio adjustments in the centralized market, an agent is unsure what trading opportunities will be available to her in the subsequent decentralized market and, hence, how much money she will want to hold. The banking literature that began with Bryant (1980) and Diamond and Dybvig (1983) showed how an institution that resembles a bank can be welfare enhancing when agents face a similar type of uncertainty. The models in this literature were written entirely in real terms, however, which limits their ability to address monetary issues such as the effects of inflation. Bencivenga