Optimal monetary interventions in credit markets

Abstract

We characterize optimal credit market interventions with respect to two fundamental frictions-limited commitment and limited monitoring. We consider two classes of interventions: an inflationary policy which uses inflation tax to forgive private debt, and a deflationary policy which uses credit tax to increase the real rate of return on money. We show that both money and debt are essential and that intervention is generically optimal. The nature of the optimal intervention depends on the fundamentals of the economy and we provide conditions under which the optimal intervention is inflationary and under which it is deflationary. Our results hold irrespective of whether we use a bargaining protocol or optimal trading mechanisms.

Liquidity: A New Monetarist Perspective

“…See Wong (2015) for an analysis without quasi-linearity. In other applications, Rocheteau (2012) studies the cost of inflation, Hu andRocheteau (2013,2015) and Araujo and Hu (2015) analyze the coexistence of money and credit or other assets, while Chiu and Wong (2015) An extension in Lagos and Rocheteau (2005) and Rocheteau and Wright (2005), on which we spend more time, has two distinct types, called buyers and sellers because in every DM the former want to consume but cannot produce while the latter produce but do not consume. This provides a natural setting to consider price posting and directed search, sometimes called competitive search equilibrium.…”

Indeterminacy in credit economies

“…To be clear, we are not advocating the use of any re…nement beyond the standard notion of subgame perfection. Since it is the equilibrium concept used in all monetary theory, re…ning the equilibrium set could lead to misleading comparisons of allocations between pure currency and pure credit environments 4. We generalize this result in a companion paper (Bethune et al, 2017) where we study, in detail, the planner's problem subject to incentive constraints 5.…”

“…Now consider a buyer with state G at the CM stage of period t, with a promise`0 made to the seller. The buyer has to pay minf`t;`0g to maintain state G. By (4), paying this amount is better than becoming an A person, whose continuation value is 0. Finally, consider a buyer with state G at the beginning of period…”

“…Moreover, these equilibria do not have better normative properties; we provide examples where there are a continuum of equilibria that dominate, from a social welfare point of view, the best equilibrium under "not-too-tight" solvency constraints. 4 Finally, by considering the full set of PBE, we uncover new equilibrium outcomes in credit markets. There are a continuum of equilibria featuring endogenous credit booms and busts, including those in which credit completely dries up and recovers later on.…”

Fiat Money as a Public Signal, Medium of Exchange, and Punishment

“…Within this environment, we characterize the equilibrium consistent with state contingent monetary policies under different government record-keeping technologies. 4 The search-theoretic approach to monetary economics argues that the important role of fiat money is its role as a medium of exchange as it increases welfare Wright (1991,1993)). The rationale is that fiat money, when functions as a medium of exchange, can (partially) resolve the double coincidence of wants problem and hence enhance welfare.…”