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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. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  2. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  3. Patrick J. Kehoe & Fabrizio Perri, 2002. "International Business Cycles with Endogenous Incomplete Markets," Econometrica, Econometric Society, vol. 70(3), pages 907-928, May.
  4. Akyol, Ahmet, 2004. "Optimal monetary policy in an economy with incomplete markets and idiosyncratic risk," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1245-1269, September.
  5. Josep Pijoan-Mas 2 & Antonia Díaz & José-Víctor Ríos-Rull, 2001. "Habit Formation: Inplications For The Wealth Distribution," Economics Working Papers we015114, Universidad Carlos III, Departamento de Economía.
  6. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-98, May.
  7. S. Rao Aiyagari & Stephen D. Williamson, 1998. "Money and dynamic credit arrangements with private information," Working Paper 9807, Federal Reserve Bank of Cleveland.
  8. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393.
  9. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  10. Edward J. Green & Ruilin Zhou, 2002. "Money as a mechanism in a Bewley economy," Working Paper Series WP-02-15, Federal Reserve Bank of Chicago.
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  15. Patrick J. Kehoe & Fabrizio Perri, 2002. "Competitive Equilibria With Limited Enforcement," NBER Working Papers 9077, National Bureau of Economic Research, Inc.
  16. David K. Levine, 1991. "Asset Trading Mechanisms and Expansionary Policy," Levine's Working Paper Archive 43, David K. Levine.
  17. Kocherlakota, Narayana R., 2003. "Societal benefits of illiquid bonds," Journal of Economic Theory, Elsevier, vol. 108(2), pages 179-193, February.
  18. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  19. Harold L. Cole & Narayana R. Kocherlakota, 1999. "Efficient allocations with hidden income and hidden storage," Staff Report 238, Federal Reserve Bank of Minneapolis.
  20. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
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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. Lizarazo, Sandra & Da-Rocha, Jose-Maria, 2011. "Optimal monetary policy and default," MPRA Paper 31931, University Library of Munich, Germany.
  3. Aleksander Berentsen & Christopher Waller, 2010. "Outside versus Inside Bonds: A Modigliani-Miller Type Result for Liquidity Constrained Economies," CESifo Working Paper Series 3272, CESifo Group Munich.
  4. Rojas-Breu, M., 2011. "Debt enforcement and the return on money," Working papers 345, Banque de France.

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