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Liquidity Risk and Banks' Asset Composition: Implications for Monetary Policy
Edgar A. Ghossoub
Southern Economic Journal
Vol. 77, No. 2 (October 2010), pp. 465-481
Published by: Southern Economic Association
Stable URL: http://www.jstor.org/stable/40997141
Page Count: 17
You can always find the topics here!Topics: Bank capital, Economic inflation, Steady state economies, Bank assets, Capital investments, Bank liabilities, Liquidity risk, Bank portfolios, Government bonds
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Monetary growth models in which the government is a net debtor demonstrate that inflation adversely affects capital formation through the crowding out effect. Interestingly, the results are at odds with empirical evidence. In particular, recent studies point to an asymmetric relationship between inflation and the real economy across countries. Specifically, inflation and output are negatively correlated in poor countries. In contrast, inflation is associated with higher levels of economic activity in advanced economies. I present a monetary growth model with public debt, where the exposure to risk is inversely related to the level of income. In this setting, I demonstrate that the effects of monetary policy depend on the level of capital of the economy. In poor countries, banks' portfolios consist primarily of government liabilities. Therefore, a higher rate of money creation inhibits capital formation in these economies. In contrast, banks devote more resources toward productive uses in advanced countries. Consequently, monetary policy generates a Tobin effect.
Southern Economic Journal © 2010 Southern Economic Association