On the Essentiality of Credit and Banking at the Friedman Rule

Paola Boel and Christopher Waller

No 2020-018, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We investigate the essentiality of credit and banking in a microfounded monetary model in which agents face heterogeneous idiosyncratic time preference shocks. Three main results arise from our analysis. First, the constrained-efficient allocation is unattainable without banks. Second, financial intermediation can improve the equilibrium allocation even at the Friedman rule because it relaxes the liquidity constraints of impatient borrowers. Third, changes in credit conditions are not necessarily neutral in a monetary equilibrium at the Friedman rule. If the debt limit is sufficiently low, money and credit are perfect substitutes and tightening the debt limit is neutral. As the debt limit increases, however, patient agents always hold money but impatient agents prefer not to since it is costly for them to do so given they are facing a positive shadow rate. Borrowing instead is costless when interest rates are zero and increasing the debt limit improves the allocation.

Keywords: Money; Credit; Banking; Heterogeneity; Friedman rule (search for similar items in EconPapers)
JEL-codes: E40 E50 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2020-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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DOI: 10.20955/wp.2020.018

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