A theory of low inflation in a non Ricardian economy with credit constraints

This paper explores the relationship between the severity of credit constraints and long run inflation in a simple non Ricardian setting. It is shown that a low positive inflation can loosen credit constraints and that this effect yields a theory of the optimal long run inflation target with no assumption concerning nominal rigidities or expectation errors. Credit constraints introduce an un-priced negative effect of the real interest rate on investment. Because of this effect, the standard characterization of economic efficiency with the Golden Rule fails to apply. When fiscal policy is optimally designed, the first best allocation can be achieved thanks to a positive inflation rate and a proportional tax on consumption.credit constraints ; long run inflation ; non Ricardian setting

The case for a financial approach to money demand

The distribution of money across households is much more similar to the distribution of financial assets than to that of consumption levels, even controlling for life-cycle effects. This is a puzzle for theories which directly link money demand to consumption, such as cash-in-advance (CIA), money-in-the-utility function (MIUF) or shopping-time models. This paper shows that the joint distribution of money and nancial assets can be explained by an incomplete-market model when frictions are introduced into financial markets. Money demand is modeled as a portfolio choice with a fixed transaction cost in financial markets.money demand ; money distribution ; heterogenous agents

The Case for a Financial Approach to Money Demand

The distribution of money across households is much more similar to the distribution of financial assets than to that of consumption levels. This is a puzzle for theories which directly link money demand to consumption. This paper shows that the joint distribution of money and financial assets can be explained in an heterogeneous agent model where both a cash-in-advance constraint and financial adjustment costs, as in the Baumol-Tobin literature, are introduced. Studying each friction in turn, I find that the financial friction explains 85% of total money demand. Classification-JEL: E40, E50.Money Demand, Money Distribution, Heterogeneous Agents.

The real effect of inflation in liquidity constrained models

This article identifies a new channel through which inflation affects the real economy. In a simple monetary model where agents face heterogenous income flows, it is proven that credit constraints create heterogeneity in money demand. Because of this heterogeneity, long run inflation affects the real interest rate and real variables, even when there are no redistributive effects, no distorting fiscal policy, no substitution between leisure and working time, and when prices are flexible. For realistic utility functions, inflation is found to raise the capital stock, but to decrease welfare.inflation ; credit constraints ; heterogenous agents

Public spending shocks in a liquidity-constrained economy

This paper analyses the effect of transitory increases in government spending when public debt is used as liquidity by the private sector. Aggregate shocks are introduced into an incomplete-market economy where heterogenous, infinitely-lived households face occasionally binding borrowing constraints and store wealth to smooth out idiosyncratic income fluctuations. Debt-financed increases in public spending facilitate self-insurance by bond holders and may crowd in private consumption. The implied higher stock of liquidity also loosens the borrowing constraints faced by firms, thereby raising labour demand and possibly the real wage. Whether private consumption and wages actually rise or fall ultimately depends on the relative strengths of the liquidity and wealth effect that are produced by the shockborrowing constraints ; public debt ; fiscal policy shocks

Time, Bifurcations and Economic Applications

In this paper,we show how to recover discrete-time models from their continuous-time versions through Euler discretizations. In the first part, we introduce general polynomial discretizations in backward and forward looking and we study the preservation of stability properties and local bifurcations under different discretizations. In the second part, we apply these results to popular growth models. We show how to reconcile the traditional Solow models in discrete and continuous time through a backward-looking discretization. Discrete-time models of endogenous saving, suchas Ramsey(1928), need hybrid discretizations of the continuous-time model because of the forward-looking nature of the Euler equation. The introduction of externalities allows us to illustrate the preservation of stability properties and local bifurcations.discretizations, bifurcations, growthmodels

Risk Shifting, Asset Bubbles, and Self-fulfilling Crises.

Financial crisis are often associated with an endogenous credit reversal fol- lowed by a fall in asset prices and failures of financial institutions. To account for this sequence of events, this paper constructs a model where the excess risk-taking of portfolio investors leads to a bubble in asset prices (in the spirit of Allen and Gale, Economic Journal, 2000), and where the supply of credit to these investors is endogenous. First, we show that changes in the composition and riskiness of investors' portfolio as total lending varies may cause the ex ante return on loans to increase with the amount of total lending, thereby creating the potential for multiple (Pareto-ranked) equilibria associated with different levels of lending, asset prices, and output. We then embed this mechanism into a 3-period model where the low-lending equilibrium is selected with positive probability at the intermediate date. This event is associated with a inefficient liquidity dry-up, a market crash, and widespread failures of borrowers.Financial crises; Credit market imperfections; self-fulfilling expectations;

Bubbles and self-fulfilling crises

Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where the excessive risk-taking of portfolio investors leads to a bubble in asset prices (in the spirit of Allen and Gale, "Bubbles and Crises", Economic Journal, 2000), and where the supply of credit to these investors is endogenous. We show that the interplay between the risk shifting problem and the endogeneity of credit may give rise multiple equilibria associated with different levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an inefficient liquidity dry-up at the intermediate date, a market crash, and widespread failures of borrowers. The possibility of multiple equilibria and self-fulfilling crises is showed to be related to the severity of the risk shifting problem in the economy.credit market imperfections ; self-fulfilling expectations ; financial crises