Credit and inflation under borrowerʼs lack of commitment Articles uri icon

publication date

  • September 2011

start page

  • 1888

end page

  • 1914

issue

  • 5

volume

  • 146

International Standard Serial Number (ISSN)

  • 0022-0531

Electronic International Standard Serial Number (EISSN)

  • 1095-7235

abstract

  • In this paper we study the effects of monetary policy on privately supplied credit in model economies where money is needed for transaction purposes and agents who default on their loans cannot participate in the credit market but are allowed to accumulate money. In our deterministic benchmark economy where agents alternate in productivity, credit has the role of smoothing consumption. We show that deflation crowds out credit completely. The reason is that deflation increases the value of being excluded from the credit market and eliminates the incentive to repay loans. When inflation is positive but low, credit, consumption smoothing and welfare increase with inflation, until inflation reaches a threshold at which the allocation is efficient and money becomes superneutral