THE MULTIPRODUCT DEPOSITORY FIRM, INTEREST-BEARING TRANSACTION BALANCES, INTEREST-BEARING RESERVES, AND UNCERTAINTY

In this paper a model of depository firm behavior is developed in which the depository institution acts as a multiple product producer. The multi-product model is an application of the general theory of value to the particular case of depository firms. It generalizes the theory of bank behavior to include production and cost aspects of banking activity as well as its financial aspects and reconciles the rivaling intermediary and firm-theoretic views on depository institutions. By so doing, it bridges the gap between models which treat depository firms as mere portfolio holders and those which analyze the check clearance function in isolation. Risk aversion, production function constraint, jointness, and multiple sources of uncertainty are simultaneously introduced. The model is used to analyze the effects of interest payment on transaction balances, interest payment on reserves of depository institutions by the Central bank, and the Central bank policy swings.