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  3. American Economic Review
  4. March 2006
  5. Money in a Theory of Banking

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Money in a Theory of Banking

  • Douglas W. Diamond
  • Raghuram G. Rajan
American Economic Review
vol. 96, no. 1, March 2006
(pp. 30–53)
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Abstract

We examine the role of banks in the transmission of monetary policy. In economies where banks use real demand deposits to finance their lending, fluctuations in the timing of production can force banks to scramble for real liquidity, or even fail, which can greatly affect lending and aggregate output. The adverse effect on output can be reduced if banks finance with nominal deposits. Nominal deposits also open a "financial liquidity" channel for monetary policy to affect real activity. The banking system may be better off, however, issuing real deposits (e.g., foreign exchange denominated) under some circumstances.

Citation

Diamond, Douglas, W., and Raghuram G. Rajan. 2006. "Money in a Theory of Banking." American Economic Review, 96 (1): 30–53. DOI: 10.1257/000282806776157759

Additional Materials

JEL Classification

  • E44 Financial Markets and the Macroeconomy
  • E52 Monetary Policy
  • G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages