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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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File URL: http://www.bankofcanada.ca/wp-content/uploads/2012/12/wp2012-43.pdf
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Paper provided by Bank of Canada in its series 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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Web page: http://www.bank-banque-canada.ca/

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  1. 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.
  2. Jonathan Chiu & Cesaire Meh, 2008. "Financial Intermediation, Liquidity and Inflation," Working Papers 08-49, Bank of Canada.
  3. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  4. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1428-1440, November.
  5. Greenwald, Bruce C & Stiglitz, Joseph E, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 229-64, May.
  6. Chao Gu & Fabrizio Mattesini & Randall Wright, 2013. "Banking: A New Monetarist Approach," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 636-662.
  7. Williamson, Stephen & Sanches, Daniel, 2009. "Money and Credit With Limited Commitment and Theft," MPRA Paper 20690, University Library of Munich, Germany.
  8. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  9. Tai-wei Hu & John Kennan & Neil Wallace, 2009. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 116-137, 02.
  10. 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.
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