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Credit and inflation under borrowerʼs lack of commitment

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  • Díaz, Antonia
  • Perera-Tallo, Fernando

Abstract

In this paper we study the effects of monetary policy on privately supplied credit in model economies where money is needed for transaction purposes and agents who default on their loans cannot participate in the credit market but are allowed to accumulate money. In our deterministic benchmark economy where agents alternate in productivity, credit has the role of smoothing consumption. We show that deflation crowds out credit completely. The reason is that deflation increases the value of being excluded from the credit market and eliminates the incentive to repay loans. When inflation is positive but low, credit, consumption smoothing and welfare increase with inflation, until inflation reaches a threshold at which the allocation is efficient and money becomes superneutral.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 146 (2011)
Issue (Month): 5 (September)
Pages: 1888-1914

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Handle: RePEc:eee:jetheo:v:146:y:2011:i:5:p:1888-1914

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Web page: http://www.elsevier.com/locate/inca/622869

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Keywords: Monetary policy Existence of credit Friedman rule Self-enforcing debt Risk sharing;

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Cited by:
  1. Aleksander Berentsen & Christopher Waller, 2008. "Outside Versus Inside Bonds," IEW - Working Papers 372, Institute for Empirical Research in Economics - University of Zurich.
  2. Aleksander Berentsen & Christopher J. Waller, 2009. "Outside versus inside bonds: a Modigliani-Miller type result for liquidity constrained economies," Working Papers 2009-056, Federal Reserve Bank of St. Louis.
  3. Rojas Breu, Mariana, 2012. "Debt enforcement and the return on money," Economics Papers from University Paris Dauphine 123456789/9608, Paris Dauphine University.
  4. Lizarazo, Sandra & Da-Rocha, Jose-Maria, 2011. "Optimal monetary policy and default," MPRA Paper 31931, University Library of Munich, Germany.

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