We are grateful to Braz Camargo, Leo Ferraris, Nobuhiro Kiyotaki, Tim Vogelsang, Warren Weber, Lucy White, Randall Wright, and seminar and conference participants at the 2008 Federal Reserve Bank of Chicago Summer Workshop on Money, Banking and Payments, the 2008 Econometric Society Summer Meetings, the 2008 Midwest Economic Theory Meetings, and the 2008 Swiss Conference on Banking and Financial Intermediation (Champery). All remaining errors are ours. Please address correspondence to: Luis Araujo, 220A Marshall-Addams Hall, East Lansing, MI 48824, U.S.A. Phone: +517-353-6621. E-mail: firstname.lastname@example.org.
ON THE ESSENTIALITY OF BANKS*
Article first published online: 29 AUG 2011
© (2011) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association
International Economic Review
Volume 52, Issue 3, pages 679–691, August 2011
How to Cite
Araujo, L. and Minetti, R. (2011), ON THE ESSENTIALITY OF BANKS. International Economic Review, 52: 679–691. doi: 10.1111/j.1468-2354.2011.00645.x
Manuscript received October 2008; revised September 2009.
- Issue published online: 29 AUG 2011
- Article first published online: 29 AUG 2011
We compare allocations sustained by credit with allocations sustained by bank notes (inside money) in a search model with decentralized trade and limited monitoring. We demonstrate that there exists a credit arrangement that is superior to inside money. However, in contrast with inside money, this arrangement is not robust to an expansion of trade that is not accompanied by an adequate increase in the degree of monitoring. Therefore, banks are essential when trade is intense and monitoring is limited. As a historical application, we argue that our model helps explain the origins of banking in Medieval and Early Modern Europe.