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Credit markets, Limited commitment and Optimal monetary policy

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  • Francesca Carapella

    (Federal Reserve Board)

Abstract

In a dynamic model with credit under limited commitment money can be essential when limited memory weakens the effects of punishment for default. There exist equilibria where both money and credit are used as media of exchange, and default occurs. In this equilibria the Friedman rule is not optimal. Inflation acts to discourage default by raising the cost of holding money, which is primarily held by defaulters. This results in relaxing the limited commitment constraint and raising welfare for all agents, including defaulting ones. The equilibrium is unique if and only if monetary policy and agents' money holdings are chosen sequentially.

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  • Francesca Carapella, 2017. "Credit markets, Limited commitment and Optimal monetary policy," 2017 Meeting Papers 1523, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:1523
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    File URL: https://economicdynamics.org/meetpapers/2017/paper_1523.pdf
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    References listed on IDEAS

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    1. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    2. Francesca Carapella & Stephen Williamson, 2015. "Credit Markets, Limited Commitment, and Government Debt," Review of Economic Studies, Oxford University Press, vol. 82(3), pages 963-990.
    3. Chao Gu & Fabrizio Mattesini & Cyril Monnet & Randall Wright, 2013. "Endogenous Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 121(5), pages 940-965.
    4. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 865-888.
    5. 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.
    6. Chao Gu & Fabrizio Mattesini & Randall Wright, 2015. "Money and Credit Redux," Working Papers 1508, Department of Economics, University of Missouri.
    7. 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, January.
    8. Chao Gu & Fabrizio Mattesini & Randall Wright, 2016. "Money and Credit Redux," Econometrica, Econometric Society, vol. 84, pages 1-32, January.
    9. Narayana R. Kocherlakota, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Oxford University Press, vol. 63(4), pages 595-609.
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