Abstract
This paper compares three institutions that offer an elastic currency – open market operations, a discount window, and a private, banknote-issuing clearinghouse – in an economy with financial markets otherwise hampered by a lack of liquidity. When this economy is subject to aggregate financial shocks, these alternative forms of central banking are shown to differ in their implications for risk-sharing. Interesting implications include (i) central bank losses and monetary innovations that are part of an efficient equilibrium; and (ii) desirable quantity restrictions at the discount window.
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