This article presents a simple equilibrium model in which collateralized credit emerges endogenously. In a frictional world, where commitment is limited and agent's actions are not publicly observable, we show that collateral can serve as a credible device that prevents the participating parties from reneging. Our theory provides a microfoundation to justify the borrowing constraints that are widely used in the existing macroeconomic models. Using the model, we explain the payment puzzle. We also show that some assets are more suitable as collateral than others with different physical properties, for example, storable asset versus durable asset.

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For money to be essential, environments have been considered in which there is imperfect monitoring of past actions and in which it is difficult to coordinate among economic agents. This paper provides an environment in which there is no monitoring of past actions while coordination is difficult. In this environment, we show that the first best allocation is achieved without money, and hence, money is not essential. The implication is that, for money to be essential, no monitoring is not enough but coordination must also be free.

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