COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 900

"Liquidity and Bankruptcy with Incomplete Markets: Pure Exchange"

John Geanakoplos and Pradeep Dubey

February 1989

We enlarge the standard model of general equilibrium with incomplete market (GEI), to incorporate liquidity constraints as well as the possibility of bankruptcy and default. A new equilibrium results, which we abbreviate GELBI (general equilibrium with liquidity, bankruptcy and incomplete markets). When the supply of bank money and bankruptcy/default penalties are taken sufficiently high (the high regime), GEI occur as GELBI. But outside the high regime many new phenomena appear: money is (almost) never neutral, it has positive value and its optimum quantity is often finite; bankruptcy and default not only occur in equilibrium but can have welfare improving consequences for everyone; there is no real indeterminacy even with financial assets.

JE Classification: 021, 022

Keywords: Incomplete markets, general equilibrium, bankruptcy, liquidity constraints