Staff Reports
Liquidity-Saving Mechanisms
April 2007 Number 282
Revised January 2008
JEL classification: E42, E58, G21

Authors: Antoine Martin and James McAndrews

We study the incentives of participants in a real-time gross settlement system with and without the addition of a liquidity-saving mechanism (queue). Participants in our model face a liquidity shock and different costs for delaying payments. They trade off the cost of delaying a payment against the cost of borrowing liquidity from the central bank. The heterogeneity of participants in our model gives rise to a rich set of strategic interactions. The main contribution of our paper is to show that the design of a liquidity-saving mechanism has important implications for welfare, even in the absence of netting. In particular, we find that parameters will determine whether the addition of a liquidity-saving mechanism increases or decreases welfare.

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For a published version of this report, see Antoine Martin and James McAndrews, "Liquidity-Saving Mechanisms," Journal of Monetary Economics 55, no. 3 (April 2008): 554-67.