Money and Credit: Theory and Applications

IMF Working Papers, January 27, 2017

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Money and Credit: Theory and Applications

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Bibliographic details

• Authors: Liang Wang, Randall Wright, Lucy Qian Liu
• Published: January 27, 2017
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781475572339.001

Summary

• We develop a theory of money and credit as competing payment instruments, then put it to work in applications.
• Buyers can use cash or credit, with the former (latter) subject to the inflation tax (transaction costs).
• Frictions that make the choice of payment method interesting also imply equilibrium price dispersion.
• We deliver closed-form solutions for money demand.
• The model can simultaneously account for the price-change facts, cash-credit shares in micro payment data, and money-interest correlations in macro data.
• We analyze the effects of inflation on welfare, price dispersion and markups.
• We describe nonstationary equilibria as self-fulfilling prophecies, which is standard, except here it entails dynamics in the price distribution.

Key findings and contributions

• Theory framing:
  • Money and credit are modeled as competing payment instruments.
  • Cash is exposed to the inflation tax; credit is exposed to transaction costs.
• Equilibrium implications:
  • Presence of frictions leads to equilibrium price dispersion.
  • Closed-form solutions for money demand are provided.
• Empirical applicability:
  • The model accounts for:
  • Price-change facts.
  • Cash-credit shares in micro payment data.
  • Money-interest correlations in macro data.
• Dynamics:
  • Nonstationary equilibria are characterized as self-fulfilling prophecies that produce dynamics in the price distribution.

Model elements and terminology

• Payment instruments: cash, credit.
• Frictions and costs: inflation tax (on cash), transaction costs (on credit).
• Price outcomes: equilibrium price dispersion; dynamics in the price distribution.
• Analytical deliverables: closed-form money demand functions.
• Technical terms preserved from the source: Burdett-Judd price, buyer-seller ratio, fixed-cost model, menu cost, nominal rate, price change, Price Dispersion, price distribution, Sticky Prices, money demand function, markups.

Policy analysis and welfare

• Analysis addresses effects of inflation on:
  • Welfare.
  • Price dispersion.
  • Markups.
• The framework links monetary variables (inflation, nominal rates) to payment method choice and macroeconomic price behavior.

Publication and metadata

• Authors: Liang Wang, Randall Wright, Lucy Qian Liu
• Date: January 27, 2017
• Series: IMF Working Papers
• Working Paper No.: 2017/014
• Issue: 014
• Volume: 2017
• Pages: 54
• DOI: https://doi.org/10.5089/9781475572339.001
• Stock No: WPIEA2017014
• ISBN: 9781475572339
• ISSN: 1018-5941
• Subject tags: Credit, Currencies, Demand for money, Inflation, Money, Prices, Sticky prices
• Keywords: Burdett-Judd price, buyer-seller ratio, Credit, Currencies, Demand for money, fixed-cost model, Global, Inflation, menu cost, Money, money demand, money demand function, nominal rate, price change, Price Dispersion, price distribution, Sticky Prices, WP

IMF Working Paper — "Money and Credit: Theory and Applications" (January 27, 2017) by Liang Wang, Randall Wright, Lucy Qian Liu.

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