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Credit markets, Limited commitment and Optimal monetary policy

Francesca Carapella
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Francesca Carapella: Federal Reserve Board

No 1523, 2017 Meeting Papers from Society for Economic Dynamics

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.

Date: 2017
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mic and nep-mon
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