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We develop a general equilibrium model of self-fulfilling bank runs in a setting without aggregate risk. The key novelty is the way in which the banking system’s assets and liabilities are connected. Banks issue loans to entrepreneurs who sell goods to households, which in turn pay for the goods by redeeming bank deposits. The return on bank assets is thus contingent on households being able to withdraw their deposits. In a run, not all households that wish to consume manage to withdraw, since part of banks’ cash reserves end up in the hands of households without consumption needs. This lowers revenues of entrepreneurs, which causes some of them to default on their loans and thereby rationalises the run in the first place. Interventions that restrict redemptions in a run – such as deposit freezes – can be self-defeating due to their negative effect on demand in goods markets. We show how runs may be prevented with combinations of deposit freezes and redemption penalties as well as with the provision of emergency liquidity by central banks., SNB Working Papers, 2022-10, ISSN:1660-7716, ISSN:1660-7724

This paper revisits how coexistence of money and bonds can make a society better off. For this purpose, a model is constructed in which payment instruments matter for settling real transactions and savings instruments matter because agents differ in how they discount future utility. Because bonds and money differ in their characteristics as payment and savings instruments, the model is able to explain the coexistence puzzle for an optimally chosen monetary policy. Such a policy trades-offs efficiency in financial markets, in which money is traded for bonds, with efficiency in goods markets, in which money is traded for a real good. Financial markets can achieve a better distribution of savings when agents are constrained by their money holdings, but this is bad for efficiency in goods markets. The former effect can dominate the latter so that optimal policy deviates from the Friedman rule

In modern economies, most money takes the form of inside money; deposits created by commercial banks to fund credit extension. Because inside money is used as a payment instrument, doubts about the risks associated with credit extension can affect aggregate outcomes. This paper constructs and analyzes a model of risky credit extension, inside money creation, and monetary exchange. When credit extension is sufficiently risky, a positive probability of bank default arises and this affects the return characteristics of inside money. Depositors then demand a risk premium for holding inside money, which drives a wedge between bankers' funding costs and the social benefits of money creation. This wedge negatively affects credit extension, output, and welfare. A government can restore efficiency by swapping risky inside money for risk-free forms of government debt.

This dissertation provides novel perspectives on economic phenomena related to the role of banks and financial markets by taking into account that such institutions create or redistribute assets that serve as payment instruments. To do so, the dissertation develops a series of microfounded models of money that adhere to the new monetarist tradition. The first part of the dissertation focuses on the creation of money-like assets by private intermediaries, such as banks. Chapter 2 investigates how an economy characterized by private money creation can be subject to self-fulfilling financial crises and recessions. Chapter 3 studies how the risk embedded in credit extension by banks can affect economic outcomes through the fact that credit extension and deposit creation are two sides of the same coin. The second part of the dissertation focuses on the current monetary policy environment, characterized by historically low nominal interest rates. Chapter 4 shows that the ability of financial markets to achieve a favorable distribution of savings is impaired when nominal interest rates are at the zero lower bound. Chapter 5 considers how optimal monetary policy depends on different types of heterogeneity across households and how this can push an economy towards or away from the zero lower bound.

We argue that long-run inflation has nonlinear and state-dependent effects on unemployment, output, and welfare. Using panel data from the OECD, we document three correlations. First, there is a positive long-run relationship between anticipated inflation and unemployment. Second, there is also a positive correlation between anticipated inflation and unemployment volatility. Third, the long-run inflation-unemployment relationship is not only positive, but also stronger when unemployment is higher. We show that these correlations arise in a standard monetary search model with two shocks - productivity and monetary - and frictions in labor and goods markets. Inflation lowers the surplus from a worker-firm match, in turn making it sensitive to productivity shocks or to further increases in inflation. We calibrate the model to match the US postwar labor market and monetary data and show that it is consistent with observed cross-country correlations. The model implies that the welfare cost of inflation is nonlinear in the level of inflation and is amplified by the presence of aggregate shocks.

We study optimal policy design in a monetary model with heterogeneous preferences. In the model markets are incomplete and households are heterogeneous with respect to their current consumption preferences and discount factors. The government controls the supply of money (liquid) and nominal bonds (illiquid) based on which households make optimal portfolio choices. We uncover that the two types of preference heterogeneity have distinct implications for the optimal policy mix of the government. While the heterogeneity in current consumption preferences pushes the economy towards a zero-lower-bound (ZLB) associated with nominal interest rates, the heterogeneity in discount factors moves the economy away from the ZLB. We characterize the optimal policy design and quantify the welfare losses associated a binding ZLB - and thus potential welfare benefits from allowing negative interest rates on government bonds.

Major central banks remunerate reserves at negative interest rates and it is increasingly likely that they will keep rates negative for many more years. To study the long run implications of negative rates, we construct a dynamic general equilibrium model with commercial banks funding investment projects and a central bank issuing reserves. Negative rates distort investment decisions resulting in lower output and welfare. These findings sharply contrast the short-run expansionary effects ascribed to negative rate policies by most of the existing literature. Negative rates also reduce commercial bank profitability. Exempting a fraction of reserves from negative rates can resolve profitability concerns without affecting the central bank's ability to control the money market rate. However, exemption thresholds do no mitigate the investment distortions created by negative rates.

Holdings of money and illiquid assets are likely to be determined jointly. Therefore, frictions that give rise to a need for money may affect capital formation, resulting in either too much or too little investment. Existing models of money and capital however tend to overlook that both types of investment inefficiencies can be equilibrium outcomes. Building upon insights from the New-Monetarist literature, we construct a model in which preference heterogeneity between agents implies that both over- and under-investment can arise. We use our framework to study whether monetary policy can effectively resolve both types of investment inefficiencies, and find that increasing inflation could resolve under-investment inefficiencies while reducing inflation could curb over-investment inefficiencies.