Question
Now we introduce banks that will act as liquidity providers in the economy. Suppose that banks are able to issue private IOU's, such that individuals
Now we introduce banks that will act as liquidity providers in the economy. Suppose that banks are able to issue private IOU's, such that individuals deposit goods with the bank and the bank can promise a return on the deposit. We start by assuming that there is no reserve requirement or lending by the Central Bank. (a) Suppose a young individual wants to use one consumption good to acquire money. What return does the bank need to promise the individual to have them deposit the good with the bank instead? (b) Suppose that when the individual deposits a good with the bank, the bank uses this good to create capital. Further, suppose that when the bank offers a return on deposits that is equal to the real rate of return on money then the individual will choose to deposit with the bank instead of acquiring money. A young individual in period t deposits one good with the bank when young. Suppose no young individuals in period t+1 make deposits. How does the bank pay the young individual from t their promised return? (c) Suppose a young individual from period t deposits n/z goods. What does the bank do with the deposit? What return does the bank need to promise the individual on their deposit? (d) In period t + 2 bank owes the young person from the previous period (the one who deposited n/z goods) a return on their deposit. How do they pay this return? (e) In period t + 2, what is the "profit" of the bank? Suppose individuals in the economy own the bank and profits in each period are paid as dividends. Are individuals better or worse off with the bank present? (f) Suppose now that the individual in period t+1 deposits n/z +1 goods instead of just n/z goods. What does the bank do with this deposit? How many consumption goods does the bank owe this individual on their deposit in period t + 2? (g) How does the bank pay the individual the return on the n/z+1 deposit in period t + 2? (h) Do individuals demand fiat money in this economy?
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