The Societal Benefits of Outside versus Inside Bonds

Christopher Waller and Aleksander Berentsen

No 110, 2007 Meeting Papers from Society for Economic Dynamics

Abstract: We use a general equilibrium model of money to compare the use of `illiquid' government-issued bonds (outside bonds) versus credit (inside bonds) to alleviate buyers' liquidity constraints. We assume all transactions must be voluntary. This implies that the central bank cannot run deflation via lump-sum taxation and that agents must voluntarily redeem their outstanding private debt obligations. When the steady state outside bond to money ratio is taken as given, the allocation with inside bonds is more likely to dominate the allocation with inside bonds. When this ratio is also a policy choice, then the allocation with illiquid outside bonds dominates the inside bond allocation.

Date: 2007
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