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On the Welfare Effects of Credit Arrangements

Author

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  • Jonathan Chiu
  • Mei Dong
  • Enchuan Shao

Abstract

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.

Suggested Citation

  • Jonathan Chiu & Mei Dong & Enchuan Shao, 2012. "On the Welfare Effects of Credit Arrangements," Staff Working Papers 12-43, Bank of Canada.
  • Handle: RePEc:bca:bocawp:12-43
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    References listed on IDEAS

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    1. Daniel, Sanches, 2011. "A dynamic model of unsecured credit," Journal of Economic Theory, Elsevier, vol. 146(5), pages 1941-1964, September.
    2. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, pages 171-195.
    3. Chiu, Jonathan & Meh, Césaire A., 2011. "Financial Intermediation, Liquidity, And Inflation," Macroeconomic Dynamics, Cambridge University Press, pages 83-118.
    4. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, pages 175-202.
    5. 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.
    6. 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, February.
    7. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
    8. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, pages 1428-1440.
    9. Chiu, Jonathan & Meh, Césaire A., 2011. "Financial Intermediation, Liquidity, And Inflation," Macroeconomic Dynamics, Cambridge University Press, pages 83-118.
    10. Bruce C. Greenwald & Joseph E. Stiglitz, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 229-264.
    11. 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.
    12. 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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    Cited by:

    1. Berentsen, Aleksander & Huber, Samuel & Marchesiani, Alessandro, 2016. "The societal benefit of a financial transaction tax," European Economic Review, Elsevier, vol. 89(C), pages 303-323.

    More about this item

    Keywords

    Credit and credit aggregates; Payment; clearing; and settlement systems;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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