Efficient Financial and Monetary Institutions

Stanford University, Stanford CA

Investigators

Abstract

The research in this project is guided by a simple principle. Suppose cer-tain societal institutions governing financial and payment arrangements are used in a wide variety of societies. Then there should be a strong presump-tion that those arrangements are economically efficient. (The idea. of course is that the arrangements were not efficient. then the societies would change them in order to achieve the same individual utility, levels at lower costs.) The key here is that the term `'efficient arrangement" is to be understood as meaning efficient subject to both resource and informational/enforcement constraints: I use the term "economic frictions" to refer to the latter type of constraints. Given this presumption of economic efficiency, the current project has two immediate goals. The first is to understand the economic frictions that make it efficient for societies to use money in conjunction with other assets. The second is to understand the economic frictions that make it, efficient for societies to use deposit insurance. The general method of attack is as follows. A class of model economies is constructed that incorporates certain informational and/or enforcement frictions that appear to be important aspects of the real world. Efficient arrangements are then constructed for the class of economies. These efficient arrangements are examined to see if they resemble real world institutions along key dimensions. If not, then the original informational and enforce-ment frictions are perturbed so as to improve the "fit" between real-world institutions and the properties of the efficient arrangements. Thus, the task is essentially one of "reverse engineering" existing institu-tions so as to understand what frictions underlie them. In this proposal, the institutions of interest are money/bond co-existence and deposit insurance. There is a simple reason why the proposed research has first-order policy relevance. If institutions are efficient responses to existing frictions, then governments and other agencies can only improve on those institutions if they can overcome the frictions that give rise to them. Doing so requires knowing what the frictions are.