American Economic Review: Vol. 94 No. 3 (June 2004)
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Liquidity, Efficiency, and Bank Bailouts
Gorton, Gary, and Lixin Huang. 2004. "Liquidity, Efficiency, and Bank Bailouts." American Economic Review, 94(3): 455-483.
Governments can efficiently provide liquidity, as when the banking system is bailed out. We study a model in which not all assets can be used to purchase all other assets at every date. Agents sometimes want to sell projects. The market price of the projects sold depends on the supply of liquidity, which is determined in general equilibrium. While private liquidity provision is socially beneficial since it allows valuable reallocations, it is also socially costly since liquidity suppliers could have made more efficient investments ex ante. There is a role for the government to supply liquidity by issuing government securities.
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