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Credit and inflation under borrower’s lack of commitment

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  • Antonia Diaz

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  • Fernando Perera-Tallo

Abstract

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.

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Bibliographic Info

Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we077946.

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Date of creation: Nov 2007
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Handle: RePEc:cte:werepe:we077946

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  1. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers, Federal Reserve Bank of Minneapolis 445, Federal Reserve Bank of Minneapolis.
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  8. Aiyagari, S. Rao & Williamson, Stephen, 1997. "Money and Dynamic Credit Arrangements with Private Information," Working Papers, University of Iowa, Department of Economics 97-19, University of Iowa, Department of Economics.
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  14. Diaz, Antonia & Pijoan-Mas, Josep & Rios-Rull, Jose-Victor, 2003. "Precautionary savings and wealth distribution under habit formation preferences," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(6), pages 1257-1291, September.
  15. Christian Hellwig & Guido Lorenzoni, 2006. "Bubbles and Self-enforcing Debt," Levine's Bibliography 321307000000000383, UCLA Department of Economics.
  16. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, Econometric Society, vol. 69(3), pages 575-98, May.
  17. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, Econometric Society, vol. 51(5), pages 1485-504, September.
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Cited by:
  1. Lizarazo, Sandra & Da-Rocha, Jose-Maria, 2011. "Optimal monetary policy and default," MPRA Paper 31931, University Library of Munich, Germany.
  2. Aleksander Berentsen & Christopher Waller, 2009. "Outside versus inside bonds: A Modigliani-Miller type result for liquidity constrained economies," IEW - Working Papers, Institute for Empirical Research in Economics - University of Zurich 443, Institute for Empirical Research in Economics - University of Zurich.
  3. Rojas Breu, Mariana, 2012. "Debt enforcement and the return on money," Economics Papers from University Paris Dauphine, Paris Dauphine University 123456789/9608, Paris Dauphine University.
  4. Aleksander Berentsen & Christopher Waller, 2008. "Outside Versus Inside Bonds," IEW - Working Papers, Institute for Empirical Research in Economics - University of Zurich 372, Institute for Empirical Research in Economics - University of Zurich.

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