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Optimal monetary interventions in credit markets

Luis Araujo and Tai-Wei Hu

Journal of Economic Theory, 2018, vol. 178, issue C, 455-487

Abstract: We characterize optimal credit market interventions with respect to two fundamental frictions—limited commitment and limited monitoring. We consider two classes of interventions: an inflationary policy which uses inflation tax to forgive private debt, and a deflationary policy which uses credit tax to increase the real rate of return on money. We show that both money and debt are essential and that intervention is generically optimal. The nature of the optimal intervention depends on the fundamentals of the economy and we provide conditions under which the optimal intervention is inflationary and under which it is deflationary. Our results hold irrespective of whether we use a bargaining protocol or optimal trading mechanisms.

Keywords: Money; Credit; Limited commitment; Optimal monetary policy; Mechanism design; Inflation (search for similar items in EconPapers)
JEL-codes: E50 E51 E52 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:jetheo:v:178:y:2018:i:c:p:455-487