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Abstract: We examine the role of money and monetary policy when competitive banks face a systemic liquidity shock. Banks cannot provide a deposit contract contingent on the systemic liquidity shock, and introducing money to the economy allows banks to provide a nominal deposit contract that leads to state-contingent real consumption for depositors while resulting in over-competition among banks at the same time. Monetary authority can always improve the depositors’ welfare through providing liquidity to the banks with liquidity shortage, however, an opposite operation of extracting liquidity from the banks with liquidity shortage can eliminate over-competition among banks ex-ante and thus help the economy to achieve the social optimal allocation.