Essays on Money and Credit: A New Monetarist Approach

Chapter 1: Money and Credit with Limited Commitment and Theft Credit contracts and fiat money seem to be robust means of payment in the sense that we observe both monetary exchange and credit transactions under a wide array of technologies and monetary policy rules. However, a common result in a large class of models of money and credit is that the optimal monetary policy -- usually the Friedman rule -- eliminates any transactions role for credit: money drives credit out of the economy. In this sense, money and credit are not robust in the model. We study the interplay among imperfect recordkeeping, limited commitment, and theft, in an environment that can support both monetary exchange and credit arrangements. Imperfect recordkeeping makes outside money socially useful, but it also permits theft of currency to go undetected, and therefore provides lucrative opportunities for thieves in decentralized exchange. First, we show that imperfect recordkeeping and limited commitment are not sufficient to account for the robust coexistence of money and credit. Then, we show that theft, together with imperfect recordkeeping and limited commitment, is sufficient to account for the robust coexistence, given that theft imposes a cost on monetary exchange. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls. Chapter 2: Unsecured Loans and the Initial Cost of Lending We study the terms of credit in a competitive market where sellers are willing to repeatedly finance the purchases of buyers by extending direct credit. Lenders: sellers) can commit to deliver any long-term credit contract that does not result in a payoff that is lower than that associated with autarky while borrowers: buyers) cannot commit to any contract. A borrower\u27s ability to repay a loan is privately observable. As a result, the terms of credit within an enduring relationship change over time according to the history of trades. Although there is free entry of lenders in the credit market, each lender has to pay a cost to contact a borrower. We show that a lower cost makes each borrower better off from the perspective of the contracting date, results in less variability in a borrower\u27s expected discounted utility, and makes each lender uniformly worse off ex post. As this cost approaches zero, the credit contract offered by a lender converges to a full-insurance contract. Chapter 3: Costly Recordkeeping, Settlement System, and Monetary Policy We study an arrangement in which the government provides a public settlement system to the private sector and evaluate its implications for the implementation of monetary policy. A key ingredient of the analysis is that it is costly for the government to operate a record-keeping technology which is necessary for the construction of a settlement system through which private loans and tax liabilities are settled. For this reason, the choice of the optimal size of a settlement system by the government is non-trivial. Another benefit of such a system is that it allows the government to effectively control the money supply. We show that the Friedman rule is suboptimal. Money and credit coexist as means of payment at the optimum. The government relies on a credit system to implement an optimal policy because of the role of credit in relaxing cash constraints. As a result, money and credit are complementary in transactions: the existence of a credit system makes the operation of a monetary system more effective