Money and Credit With Limited Commitment and Theft

We study the interplay among imperfect memory, limited commitment, and theft, in an environment that can support monetary exchange and credit. Imperfect memory makes money useful, but it also permits theft to go undetected, and therefore provides lucrative opportunities for thieves. Limited commitment constrains credit arrangements, and the constraints tend to tighten with imperfect memory, as this mitigates punishment for bad behavior in the credit market. Theft matters for optimal monetary policy, but at the optimum theft will not be observed in the model. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls.

Money and Credit With Limited Commitment and Theft

We study the interplay among imperfect memory, limited commitment, and theft, in an environment that can support monetary exchange and credit. Imperfect memory makes money useful, but it also permits theft to go undetected, and therefore provides lucrative opportunities for thieves. Limited commitment constrains credit arrangements, and the constraints tend to tighten with imperfect memory, as this mitigates punishment for bad behavior in the credit market. Theft matters for optimal monetary policy, but at the optimum theft will not be observed in the model. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls.Money; Credit; Limited Commitment; Monetary Policy

Essays on Money and Credit: A New Monetarist Approach

Chapter 1: Money and Credit with Limited Commitment and Theft Credit contracts and fiat money seem to be robust means of payment in the sense that we observe both monetary exchange and credit transactions under a wide array of technologies and monetary policy rules. However, a common result in a large class of models of money and credit is that the optimal monetary policy -- usually the Friedman rule -- eliminates any transactions role for credit: money drives credit out of the economy. In this sense, money and credit are not robust in the model. We study the interplay among imperfect recordkeeping, limited commitment, and theft, in an environment that can support both monetary exchange and credit arrangements. Imperfect recordkeeping makes outside money socially useful, but it also permits theft of currency to go undetected, and therefore provides lucrative opportunities for thieves in decentralized exchange. First, we show that imperfect recordkeeping and limited commitment are not sufficient to account for the robust coexistence of money and credit. Then, we show that theft, together with imperfect recordkeeping and limited commitment, is sufficient to account for the robust coexistence, given that theft imposes a cost on monetary exchange. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls. Chapter 2: Unsecured Loans and the Initial Cost of Lending We study the terms of credit in a competitive market where sellers are willing to repeatedly finance the purchases of buyers by extending direct credit. Lenders: sellers) can commit to deliver any long-term credit contract that does not result in a payoff that is lower than that associated with autarky while borrowers: buyers) cannot commit to any contract. A borrower\u27s ability to repay a loan is privately observable. As a result, the terms of credit within an enduring relationship change over time according to the history of trades. Although there is free entry of lenders in the credit market, each lender has to pay a cost to contact a borrower. We show that a lower cost makes each borrower better off from the perspective of the contracting date, results in less variability in a borrower\u27s expected discounted utility, and makes each lender uniformly worse off ex post. As this cost approaches zero, the credit contract offered by a lender converges to a full-insurance contract. Chapter 3: Costly Recordkeeping, Settlement System, and Monetary Policy We study an arrangement in which the government provides a public settlement system to the private sector and evaluate its implications for the implementation of monetary policy. A key ingredient of the analysis is that it is costly for the government to operate a record-keeping technology which is necessary for the construction of a settlement system through which private loans and tax liabilities are settled. For this reason, the choice of the optimal size of a settlement system by the government is non-trivial. Another benefit of such a system is that it allows the government to effectively control the money supply. We show that the Friedman rule is suboptimal. Money and credit coexist as means of payment at the optimum. The government relies on a credit system to implement an optimal policy because of the role of credit in relaxing cash constraints. As a result, money and credit are complementary in transactions: the existence of a credit system makes the operation of a monetary system more effective

The simple analytics of money and credit in a quasi-linear environment

Lagos and Wright (2005) demonstrate how the essential properties of a money-search model are preserved in an environment that is rendered highly tractable with the use of quasi-linear preferences. In this paper, I show that this same innovation can be applied to closely related environments used elsewhere in the literature that study insurance and credit markets under limited commitment and private information. The analysis demonstrates clearly how insurance, credit, and money are interrelated in terms of their basic functions. The analysis also leads to a heretofore neglected result pertaining to the Friedman rule. In particular, I find that the same frictions that render money essential may at the same time operate to render the Friedman rule infeasible. Thus, even if the Friedman rule is a desirable policy, an incentive-induced lower bound on the rate of deflation may nevertheless entail a strictly postive rate of inflation.Money ; Credit

Another Example of a Credit System that Coexists with Money

We study an economy in which exchange occurs pairwise, there is no commitment, and anonymous agents choose between random monetary trade or deterministic credit trade. To accomplish the latter, agents can exploit a costly technology that allows limited recordkeeping and enforcement. An equilibrium with money and credit is shown to exist if the cost of using the technology is sufficiently small. Anonymity, record-keeping and enforcement limitations also permit some incidence of default, in equilibrium

Money and Credit as Means of Payment: A New Monetarist Approach

This paper studies the choice of payment instruments in a simple model where both money and credit can be used as means of payment. We endogenize the acceptability of credit by allowing retailers to invest in a costly record-keeping technology. Our framework captures the two-sided market interaction between consumers and retailers, leading to strategic complementarities that can generate multiple steady-state equilibria. In addition, limited commitment makes debt contracts self-enforcing and yields an endogenous upper bound on credit use. So long as record-keeping is imperfect, money and credit coexist for a range of nominal interest rates. Our model captures the dependence of debt limits on monetary policy and explains how hold-up problems in technological adoption prevent retailers from accepting credit as consumers continue to coordinate on cash usage. With limited commitment, changes in monetary policy generate multiplier effects in the credit market due to complementarities between consumer borrowing and the adoption of credit by merchants

Limited Commitment and the Demand for Money

Understanding money demand is important for our comprehension of macroeconomics and monetary policy. Its instability has made this a challenge. Common explications for the instability are financial regulations and financial innovations that shift the money demand function. We provide a complementary view by showing that a model where borrowers have limited commitment can significantly improve the fit between the theoretical money demand function and the data. Limited commitment can also explain why the ratio of credit to M1 is currently so low, despite that nominal interest rates are at their lowest recorded levels

Essays on Macroeconomics and Monetary Economics

My essays that are captured in two chapters of my dissertation focus on shadow banking system, collateralized debt arrangement and monetary policy. The first chapter studies the role of shadow banking in the recent financial crisis, the relationship between shadow banking and traditional banking, and it investigates the monetary policy reaction to overcome the financial frictions associated with the scarcity of collateral or shortages of safe assets that naturally led to the liquidity constraints. On the other hand, the second chapter studies the role of housing as a collateral or as a medium of exchange and it explores how the private liquidity, in the context of home-equity loans, and public liquidity work together to overcome the limited commitment frictions. In the first chapter, a Lagos-Wright model with costly-state verification and delegated monitoring financial intermediation, and a risk-sharing framework of banking is constructed. Lack of memory and limited commitment imply collateralized credit arrangements. In contrast to the traditional banking system, shadow banking system is not subject to the capital requirements. The relative use of shadow funded credit versus traditional bank loans entails the advantages of working outside the oversight of the bank regulations, but drawbacks of having information and transactions cost in funding entrepreneurs. I have five main findings: First, an entrepreneurial credit can help address the need for collateral. Second, the shadow funded credit shifts from risky to safer borrowers and loan creation capacity of the shadow banking sector shrinks when the economic outlook gets worse. Third, the traditional bank can fulfill the role of providing credit that shadow banks had played before the crisis, but can do it only to a certain extent. Fourth, to the extent that collateral backed by entrepreneurial credit mitigates the limited commitment friction in the traditional banking sector, the optimal monetary policy shifts nominal interest rate towards zero lower bound. Lastly, the quantitative easing program can be welfare increasing by reinforcing the shadow funded credit versus traditional banking lending if the credit frictions in the shadow banking sector are sufficiently small. The second chapter studies the role of home-equity loan and government debt in an environment with financial frictions. I construct a Lagos-Wright model in which private transactions must be secured under limited commitment and lack of record-keeping. Housing can be useful to support credit since it serves as collateral. It also gives direct utility as shelter and serves as a medium of exchange when the economy is inefficient. I show that when there is no efficiency loss due to exchange of housing, posting collateral is not optimal since collateralizable wealth is limited. In the state of efficiency loss, the collateral might be useful and the asset therefore bears a liquidity premium. However, once collateral becomes scarce - as it did during the financial crisis- then it amplifies the frictions and the buyer trades the asset to make up for the weak incentives associated with collateral. I show that the world is always non-Ricardian and therefore government debt implies higher welfare. As well, government debt enhances the private debt to the extent that posting collateral is always optimal. In equilibrium, full pledgeability of private collateral, in addition to government debt, completely rules out the efficiency loss arising from exchange of asset. Money and private banks are introduced. I show that as inflation imposes a tax on consumption, interest rate on cash loans imposes a tax on housing collateral. Finally, an increase in inflation raises the housing price near Friedman Rule

Credit and inflation under borrower’s lack of commitment

Here we investigate the existence of credit in a cash-in-advance economy where there are complete markets but for the fact that agents cannot commit to repay their debts. Defectors are banned from the credit market but they can use money balances for saving purposes. Without uncertainty, deflation crowds out credit completely. The equilibrium allocation, however, is efficient if the government deflates at the time preference rate. Efficiency can also be restored with positive inflation. For any non negative inflation rate below the optimal level, the volume of credit and the real interest rate increase with inflation. Our results hold when idiosyncratic uncertainty is introduced and households are sufficiently impatient but in one instance: efficiency cannot be restored if the deflation rate is nearby the rate of time preference. Our numerical examples suggest that the optimal inflation rate is not too large for reasonable levels of patience and risk aversion. Finally, we present a framework where the use of money arises endogenously and show that it is tantamount to our cash-in-advance framework. Our results hold in this modified environment