Money and Credit With Limited Commitment and Theft

By Stephen Williamson and Daniel Sanchez

http://d.repec.org/n?u=RePEc:pra:mprapa:20690&r=dge

We study the interplay among imperfect memory, limited commitment, and theft, in an environment that can support monetary exchange and credit. Imperfect memory makes money useful, but it also permits theft to go undetected, and therefore provides lucrative opportunities for thieves. Limited commitment constrains credit arrangements, and the constraints tend to tighten with imperfect memory, as this mitigates punishment for bad behavior in the credit market. Theft matters for optimal monetary policy, but at the optimum theft will not be observed in the model. 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.

Money can compensate for the lack of commitment and for imperfect record keeping, however it can also be stolen. What does this imply for the money supply? Under which conditions are money and credit robust? This is an incredibly rich model that allows to understand when money and credit can both be used, and when not. It shows that money can be so powerful that it shuts down lending, under the Friedman rule. I will need more time to digest this paper, maybe others have some comments on it as well.