IMF Working Papers

Inside (the) Money Machine: Modeling Liquidity, Maturity and Credit Transformations

By Shalva Mkhatrishvili

August 22, 2025

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Format: Chicago

Shalva Mkhatrishvili. "Inside (the) Money Machine: Modeling Liquidity, Maturity and Credit Transformations", IMF Working Papers 2025, 166 (2025), accessed August 23, 2025, https://doi.org/10.5089/9798229020176.001

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

The key function of banks in the real world is endogenously creating (inside) money. But they do so facing solvency, liquidity and maturity risks and being subject to regulatory and demand constraints. These five aspects, representing the eventual breaks on banks’ money-creation abilities, are tightly and nonlinearly interlinked. Yet, there is no tractable quantitative macro framework that models endogenous money creation while simultaneously addressing these interlinkages. In this paper we develop a tractable macro-banking model trying to fill this gap, emphasizing two key frictions: the capital adequacy constraint (generating a credit risk premium) and the central bank’s collateral base constraint (generating a liquidity risk premium). The model simulations produce conclusions, about both normal times as well as stress episodes, many of which were frequently overlooked. For instance, it shows how – within capital requirements – setting lower risk weights on secured loans may lead to an expansion of unsecured loans. It also reveals subtle interactions between capital and liquidity regulations. The model also creates a certain bridge between a money-centered view of the price level and the fiscal theory of the price level.

Subject: Asset and liability management, Bank credit, Central bank policy rate, Central Banks, Collateral, Credit, Credit risk, Currency issuance, Financial institutions, Financial regulation and supervision, Financial services, Financial statements, Liquidity, Liquidity risk, Loans, Money, Public financial management (PFM)

Keywords: Bank credit, Central bank policy rate, Collateral, Credit, Credit risk, Currency issuance, Endogenous Money Creation, Financial statements, Fiscal Theory of the Price Level, Liquidity, Liquidity risk, Loans, Macro-Banking Modeling, Macroprudential Policy, Monetary base, Monetary Policy

Publication Details

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