Self-fulfilling runs and endogenous liquidity creation

This paper incorporates endogenous money creation into the liquidity mismatch problem of Diamond and Dybvig (1983). We characterize a nominal economy where demandable deposits are created through lending. Depositors use sight deposits to buy consumption goods and the banks manage reserves to clear payments and to offset liquidity risk. We show that deposit contracts are suboptimal in terms of liquidity risk-sharing. We also observe that self-fulfilling runs depend on the refinancing rate of the central bank. Our analysis emphasizes the importance of effective lender of last resort policies to prevent expectational banking panics.
Rodríguez Mendizábal would like to acknowledge the financial support from the Spanish Ministry of Economy and Competitiveness, through the Severo Ochoa Programme for Centres of Excellence in R&D (SEV-2015-0563) and through grant ECO2016-76734-P (AEI/FEDER, UE) as well as that of the Generalitat de Catalunya through Grant 2017 SGR 1571. He is also grateful for financial support from the ADEMU project, “A Dynamic Economic and Monetary Union”, funded by the European Union's Horizon 2020 Program under grant agreement No 649396.