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Speculative and Precautionary Demand for Liquidity in Competitive Banking Markets

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  • Dietrich, Diemo
  • Gehrig, Thomas
Abstract
In standard models a preference for liquidity arises because investors want to take precautions against sudden expenditure needs. We propose that investors may also want to preserve flexibility in case better investment opportunities arrive later. The co-existence of both investor types is crucial for the scope and limits of bank liquidity creation. Co-existence can entail welfare gains in a friction-free world. However, when standard financial frictions apply, co-existence can result in welfare losses relative to a world with only a single investor type. In either case, policy recommendations based only on a single motive for liquidity demand may be seriously misguided.

Suggested Citation

  • Dietrich, Diemo & Gehrig, Thomas, 2022. "Speculative and Precautionary Demand for Liquidity in Competitive Banking Markets," CEPR Discussion Papers 15827, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:15827
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    More about this item

    Keywords

    Expenditure needs; Investment opportunities; Liquidity insurance; Penalty rates; Competitive bank business models;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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