Money in the Equilibrium of Banking1

Money is both the medium for transaction and most liquid asset banks. We examine roles of money in an integrated framework, where banks are subject to aggregate illiquidity risk. An active central bank can replicate constrained efficient allocation, which, however, cannot be implemented market equilibrium: due moral hazard problems, invest excessively illiquid assets, forcing provide liquidity at low interest rates. rate policy aiming reduce systemic risk dynamically inconsistent. Instead, efficiency achieved by imposing ex ante coverage requirement.