How should governments create liquidity?

Safe assets (liquidity) can be created by an economy's private banking system and also by its government. Our model shows that some banks create liquidity with low debt and efficient loan monitoring while other banks use high, tranched debt and inefficient loan monitoring. Government liquidity can also differ, either by the government directly issuing debt or by insuring bank deposits. Directly issued government debt allows for greater private liquidity, more efficient bank lending, and greater welfare for savers. Government insurance of bank deposits crowds out private liquidity but leads to greater bank lending and profits.