Money, Banking, and Monetary Policy

Abstract

One important function of banks is to issue liabilities, like demand deposits, that are relatively safe and also liquid (usable as means of payment). We introduce risk of theft and a safe-keeping role for banks into monetary theory. This provides a general equilibrium framework for analyzing banking in historical and contemporary contexts. The model can generate concurrent circulation of cash and bank liabilities as media of exchange (inside and outside money), and yields novel policy implications. For example, negative nominal interest rates are feasible, and for some parameters optimal; for other parameters, strictly positive rates (inflation above the Friedman Rule) are optimal.