Working Papers

Easy Money: the Inefficient Supply of Inside Liquidity
Revise and Resubmit at JPE Macro 

Latest Version: December 2022 

In modern market economies, money supply depends more on liquid debt securities, such as deposits and commercial paper, created by financial intermediaries. However, the recent financial crisis has exposed the fragility of this source of liquidity. This paper outlines a model in which currency, safe liabilities, and risky liabilities all provide liquidity services. By setting the inflation rate, the central bank controls the level of liquid assets, but its composition is left to the market. During normal times, intermediaries provide ample amounts of liquidity, while during a crisis there is a large drop in the liquidity supply because of defaults of risky securities. Optimal policy aims to reduce these fluctuations in the supply of liquid assets by reducing the supply of risky securities. When studied individually, lump-sum taxes and equity requirements all contribute to restoring efficiency. However, liquidity requirements fail to achieve the social optimum since they redistribute currency without curbing the issuance of risky securities.

Work in Progress

The Deposit Channel of Fiscal Policy 

with X. Liu and G. Pan 

Using a novel bank-specific state tax rate dataset in the United States, we explore how banks pass through their tax burdens to depositors in a quasi-experimental setting. Specifically, we examine the bank branch’s deposit rates near the borders of states that experienced tax changes. We find that a one percentage point increase in the tax rate generates a decrease in bank’s deposit rate by four to five basis points, but the change would not affect credit unions. After controlling for competition at the county level, we observe that the bank’s pass-through of tax burdens is stronger in counties where banks compete less. Using a simple model, we suggest tax-induced competition environment is the primary driver of the fiscal policy pass-through for banks. While local competition mitigates banks’ tax pass-through to depositors, raising tax would also erode local competition.