The Structure of Production and Endogenous and Exogenous Liquidity of Financial Intermediaries

Abstract Banks directly manage their own liquidity. Banks also indirectly manage the liquidity of the entire economic system. In this article we discuss the relationship between endogenous and exogenous bank liquidity, and their corresponding relationship to the structure of production. We explore these liquidity relationships in the context of both a decentralized and centralized system of free banking, comparing both with the monopoly regime of central banks, “convertible and inconvertible liabilities. We analyze the incentives that engender a liquid “system in the context of free banking as well as the perversion of those same incentives in the context of central banking, which leads to breakdowns in the system’s ability to maintain liquidity. Additionally, we touch upon the fact that the criteria for individual liquidity and systemic liquidity do not coincide. They differ, and we explain their difference in a more expansive treatment of the concept of exogenous liquidity. Regarding that concept, as of late, central banks have been employing increasingly lax criteria for what constitutes eligible collateral that might be monetized.