This paper introduces a bubbly asset into the Matsuyama (2007) model with credit market imperfections and multiple technologies and shows that there can exist multiple bubbly steady states and bubbles may cause underdevelopment traps by preventing the adoption of high productivity technology.

JEL classification: E42 E51 G21 Keywords:Overlapping generations Money Interbank markets Limited commitment The lender of last resort a b s t r a c t This paper presents a monetary model in which interbank markets have limited commitment to contracts. Limited commitment reduces the proportion of assets that can be used as collateral, and thus banks with high liquidity demands face borrowing constraints in interbank markets. These constraints can be relieved by the central bank (a lender of last resort) through the provision of liquidity loans. I show that the constrained-efficient allocation can be decentralized by controlling only the money growth rate if commitment to interbank contracts is not limited. Otherwise, a proper combination of central bank loans and monetary policy is needed to bring the market equilibrium into a state of constrained efficiency.

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In this paper, I examine the differences in optimal monetary policy in various banking systems. In particular, I compare two monetary economies: one with a competitive banking system and the other with a monopolistic one. In addition, the optimality of the discount window policy is considered. It is shown that the Friedman rule is the optimal monetary policy in a monopolistic banking economy, and the zero-inflation policy is optimal in a competitive banking economy under appropriate parameters. In addition, the combination of the Friedman rule and the discount window policy can achieve efficient allocation in both banking systems.JEL codes: E42, E58, G21