On the coexistence of money and credit
This thesis explores the idea of money and credit as complementary media of exchange. Complementarity has interesting implications for the effects of monetary policy on macro-economic variables. The impact of inflation is markedly different in a world in which money and credit are complementary or substitute, i.e. cooperate or compete. In the first chapter, I review some recent literature on the coexistence of money and credit in matching models of money a la Kiyotaki and Wright and in models with spatial separation a la Townsend. I argue that the literature, virtually without exceptions, has seen money and credit as competing media of exchange and concentrated on the role of record keeping technologies in supporting credit as a medium of exchange. Moreover, money doesn't normally serve to clear debts. In chapter 2, I construct an economy with microfoundations for the use of money and bilateral credit as media of exchange. The model features spatial separation, absence of double coincidence of wants and competitive markets. Money is the means of payment: in equilibrium, bilateral credit is paid back with money. Money and credit are complementary. Complementarity generates a reverse Mundell-Tobin effect. The nominal interest rate is more than unit elastic in the inflation rate and therefore the real interest rate increases with inflation. The credit to money and credit to output ratios, output and welfare all decrease with inflation. A model in which the two media of exchange are complementary generates opposite predictions for the effect of inflation on credit with respect to a model where the two media of exchange are substitute. In chapter 3, I consider a modification of the model presented in the previous chapter to show that the elasticity of the interest rate could be less than one without affecting other results. To distinguish between the two cases, I use macroeconomic data for 59 countries over the period 1993-2003 and I estimate the elasticity of the nominal interest rate with respect to the inflation rate using weighted least square with GDP as a weight. I find an elasticity significantly greater than one. I also test the prediction on the effect of inflation on credit/GDP. Chapter 4 discusses three potentially interesting applications of the model. First a model in which agents in equilibrium endogenously decide to become debtors or creditors. Second the issue of seigniorage and finally the question of circulation of promises. In chapter 5, I consider the question of coexistence and social benefits of having a zero rate of return asset -fiat money- and an illiquid nominal, risk-free, interest bearing bond. I consider the model by Kocherlakota (2003) where illiquid bonds coexist with money because they serve to insure against liquidity shocks. I introduce a commitment technology giving agents the ability to issue promises fully backed by bonds. I show that illiquidity is not sufficient to guarantee a role for bonds. For illiquid bonds to be essential some legal restrictions on the issue of promises backed by bonds should be introduced. Finally I present a model in which changes in the liquidity of assets generate interesting predictions about the riskiness of projects undertaken in the economy, output and welfare. In the last chapter, coauthored with Raoul Minetti, we develop a theory of the interaction between the entry of lenders and the real sector.