DP19607 Credit Enforcement and Monetary-Policy Transmission
We study how the degree of credit enforcement matters for the transmission of long-run inflation and the welfare effect of private-money creation. We do so in a model with directed and competitive search, where sellers borrow against their search-market income. Intermediaries sell the arising claims as private money to buyers, who use it along with fiat money to transact in the search market. Inflation stimulates borrowing by curbing real interest rates. With sophisticated enforcement, sellers borrow more through ex-ante commitment to more search, as this increases their search-market income. Trade therefore accelerates. With simple enforcement, commitment is not feasible. The inflation-driven increase in borrowing then decelerates trade since debt distorts search incentives ex post. We calibrate the economies with sophisticated and simple enforcement to U.S. data. The extent of private-money creation is close to optimal in the sophisticated-enforcement calibration, whereas in the simple-enforcement calibration, any level of private-money creation reduces welfare.
