Effciency is achieved via a payment system that assigns balances to participants, adjusts them based on the histories of transactions, and periodically resets them through settlement. Our analysis addresses two key issues in the design of actual payment systems. First, efficient use of information requires that agents participating in transactions that do not involve monitoring frictions subsidize those that are subject to such frictions. Second, the payment system should explore the trade-off between higher liquidity costs from settlement and the need to provide intertemporal incentives. In order to counter a higher exposure to default, an increase in settlement costs implies that the volume of transactions must decrease, but also that the frequency of settlement must increase.
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Working Paper
A Dynamic Model of the Payment System
October 2007
WP 07-22 – The authors study the design of efficient intertemporal payment arrangements when the ability of agents to perform certain welfare-improving transactions is subject to random and unobservable shocks.