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Money, Credit and Default

  • Sandra Lizarazo

    ()

    (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))

  • Jose Maria Da-Rocha

    ()

    (Facultade de Ciencias Económicas e Empresariais, Universidade de Vigo)

This paper develops a quantitative model of unsecured debt, default, and money demand for heterogenous agents economies. The paper generates a theory of money demand for the case in which money is a dominate asset that is not needed to carry-out transactions. In this environment holding money helps the agents to smooth their consumption during those periods in which they are excluded from credit markets following a default in their debts. In the model the welfare of the individuals is affected by the inflation rate: high inflation rates preclude individuals of using money as an asset that helps them smooth their consumption profile but low inflation rates tend to make softer the punishment for default making it diffcult to sustain high levels of debt at equilibrium. This two opposite effects imply that in equilibrium the inflation rate that maximizes individuals welfare is positive but not too high.

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Paper provided by Centro de Investigacion Economica, ITAM in its series Working Papers with number 0908.

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Length: 12 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:cie:wpaper:0908
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