This paper documents a strong connection between payment system and credit supply. The dual role of deposits as financing instruments for banks and means of payment for the rest of the economy implies liquidity spillover effects of bank lending. After loans are financed by new deposits, the deposit holders’ payments cause reserves and deposits to flow from the lending bank to the payees’ banks. We model a linear-quadratic game of bank lending on a random graph of payment flows. Network topology determines the money multiplier that connects the liquidity in the banking system (i.e., reserves) and the creation of credit and deposits. We quantify the liquidity percolation in payment system using transaction-level data and structurally estimate the network effects. Network externalities distort the money-multiplier mechanism, reducing the level of aggregate credit supply by 9% on average and amplifying the volatility by 20%. A small subset of banks are critically positioned in the network and are systemically important as their shocks have a disproportionately large influence on aggregate credit supply.
Keywords: Credit supply, money multiplier, payment, network, externalities, systemic risk
For more information please visit the Stern Macroeconomics website.
If you would like to be added to the distribution list or for further details regarding this seminar, please contact Erica Loh at firstname.lastname@example.org.