Sticky Prices and Costly Credit

Abstract

We develop a theory of money and credit as competing payment instruments, then put it to work in applications. Agents use cash and credit because the former (latter) is subject to the inflation tax (transaction costs). Frictions that make the choice of payment method interesting also imply equilibrium price dispersion. We derive closed‐form solutions for money demand, and show how to simultaneously account for the price‐change facts, cash–credit shares in micro data, and money‐interest correlations in macro data. The effects of inflation on welfare, price dispersion and markups are discussed, as are nonstationary equilibria with dynamics in the price distribution.

Cash: A Blessing or a curse?

“…Our choice of a cash-credit model, along the lines of Lucas and Stokey (1987) , provides a tractable framework that allows for a simple welfare analysis of the restrictions on cash usage. Related effort s to give an explicit account of the fundamental transactions choices, and hence of the fundamental nature of the welfare costs, such as Alvarez and Lippi (2017) ; Deviatov and Wallace (2014) ; Gomis-Porqueras et al (2014) ; Wang et al (2020) , provide an interesting avenue for future research towards a deeper understanding of the costs and benefits of cash usage.…”