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On the Welfare Effects of Credit Arrangements

  • Jonathan Chiu
  • Mei Dong
  • Enchuan Shao

This paper studies the welfare effects of different credit arrangements and how these effects depend on the trading mechanism and inflation. In a competitive market, a deviation from the Friedman rule is always sub-optimal. Moreover, credit arrangements can be welfare-reducing, because increased consumption by credit users will drive up the price level so that money users have to reduce consumption when facing a binding liquidity restraint. By adopting an optimal trading mechanism, however, these welfare implications can be overturned. Price discrimination under the optimal mechanism helps internalize the price effects. First, small deviations from the Friedman rule are no longer welfare-reducing. Second, increasing the access to credit becomes welfare-improving. Finally, the model is extended to study the welfare effects of credit systems when credit serves as means of payment, and endogenous credit constraint.

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Paper provided by Bank of Canada in its series Staff Working Papers with number 12-43.

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Length: 60 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:bca:bocawp:12-43
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  1. Sanches, Daniel & Williamson, Stephen, 2010. "Money and credit with limited commitment and theft," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1525-1549, July.
  2. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 175-202, 01.
  3. Tai-wei Hu & John Kennan & Neil Wallace, 2007. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," NBER Working Papers 13310, National Bureau of Economic Research, Inc.
  4. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1428-1440, November.
  5. Aleksander Berentsen & Gabriele Camera & Christopher Waller, . "Money, Credit and Banking," IEW - Working Papers 219, Institute for Empirical Research in Economics - University of Zurich.
  6. Chiu, Jonathan & Meh, C├ęsaire A., 2011. "Financial Intermediation, Liquidity, And Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 83-118, April.
  7. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  8. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "A model of private bank-note issue," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 104-136, January.
  9. repec:tpr:qjecon:v:101:y:1986:i:2:p:229-64 is not listed on IDEAS
  10. repec:oup:restud:v:80:y:2013:i:2:p:636-662 is not listed on IDEAS
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