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Optimal Monetary Policy in a Model of Money and Credit




  • We thank Paul Evans, Steve Williamson, Rody Manuelli, Gaetano Antinolfi, Chris Waller, David Andolfatto, Albert Marcet, and Yinting Li. We also thank the seminar participants at the Federal Reserve Bank of St. Louis and the participants of the SWIM 2009 and the 2010 Summer Workshop on Money, Banking, Payments, and Finance at the Federal Reserve Bank of Chicago. Finally, we would like to thank two anonymous referees for their valuable suggestions. The views expressed in this paper are those of the authors and do not necessarily reflect those ofthe Federal Reserve Bank of Philadelphia or the Federal Reserve System.


We investigate the extent to which monetary policy can enhance the functioning of the private credit system. Specifically, we characterize the optimal return on money in the presence of credit arrangements. There is a dual role for credit: it allows buyers to trade without fiat money and also permits them to borrow against future income. However, not all traders have access to credit. As a result, there is a social role for fiat money because it allows agents to self-insure against the risk of not being able to use credit in some transactions. We consider a (nonlinear) monetary mechanism that is designed to enhance the credit system. An active monetary policy is sufficient for relaxing credit constraints. Finally, we characterize the optimal monetary policy and show that it necessarily entails a positive inflation rate.