, the value of
t
is the limit that the investing entrepreneur can resell his
equity holding before he misses the investment opportunity. Thus, we call
as borrowing constraint, call
t
as "resaleability constraint", and call both
constraints together as "liquidity constraints". Here, we take both and
t
as exogenous parameters and consider a stochastic shock to
t
as "liquidity
shock".
4;5
The question is to what extent does these liquidity constraints inhibit
the e¢ cient transfer of resources from savers to investors. There may be a
role for money to lubricate the transfer of additional resources. Whether or
not agents use money is determined endogenously. We show that for high
enough values of and average
t
money is not used and has no value in
the neighbourhood of the steady state. But for lower values of and average
t
, money plays an essential role. In the latter case, we call the economy a
monetary economy.
We …nd that a necessary feature of a monetary economy is that the in-
vestment of entrepreneurs is limited by liquidity constraints. He cannot raise
the entire cost of investment externally, given that the borrowing constraint
binds for the sale of new equity. That is, he has to make a downpayment
for each unit of investment from his own internal funds. But in trying to
raise funds to make this downpayment, he is constrained by how much of his
equity holding can b e sold in time: the resaleability constraint binds here. In
this sense, an investing entrepreneur …nds money more valuable than equity,
because he can use all of his money to …nance new investment whereas he
can use only a fraction
t
of his equity: money is more liquid than equity.
6
4
In Kiyotaki and Moore (2003, 2005b), we develop a framework in which the resaleabil-
ity constraint arises endogenously due to adverse selection in resale market. Each new
capital comprises a large number of parts, some of which will eventually fail (depreciate
completely), although nobody knows which when the new capital is produced. Overtime,
the insiders (producing entrepreneurs and thos e who bought the new equity) learn pri-
vately which parts will fail. If the fraction of failing parts is large enough, no outsider
will buy second-hand equity for fear of being sold lemons.
In order to overcome the adverse selection problem, the investing entrepreneur can spend
extra resource to bundle all the parts of the new capital together in such a way that they
cannot later unbundled. Then the equity issued against bundled new capital will be resold
freely.
5
In the analysis of …nancial market, Brunnermeier and Perdersen (2007) use notion of
"funding liquidity" to refer borrowing constraint and "market liquidity" to refer resaleabil-
ity constraint.
6
In practice, there are clearly di¤erences between kinds of equities –e.g. betweeen the
share of a large publicly-traded company and stock of a small privately-held business.
4