Working Paper: CEPR ID: DP14057
Authors: Ricardo Lagos; Shengxing Zhang
Abstract: We study the transmission of monetary policy in credit economies where money serves as a medium of exchange. We find that—in contrast to current conventional wisdom in policy-oriented research in monetary economics—the role of money in transactions can be a powerful conduit to asset prices and ultimately, aggregate consumption, investment, output, and welfare. Theoretically, we show that the cashless limit of the monetary equilibrium (as the cash-and-credit economy converges to a pure-credit economy) need not correspond to the equilibrium of the nonmonetary pure-credit economy. Quantitatively, we find that the magnitudes of the responses of prices and allocations to monetary policy in the monetary economy are sizeable—even in the cashless limit. Hence, as tools to assess the effects of monetary policy, monetary models without money are generically poor approximations— even to idealized highly developed credit economies that are able to accommodate a large volume of transactions with arbitrarily small aggregate real money balances.
Keywords: asset prices; cashless; credit; leverage; liquidity; margin; monetary policy
JEL Codes: D83; E52; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| medium-of-exchange role of money (E40) | asset prices (G19) |
| medium-of-exchange role of money (E40) | aggregate consumption (E20) |
| medium-of-exchange role of money (E40) | investment (G31) |
| medium-of-exchange role of money (E40) | output (C67) |
| medium-of-exchange role of money (E40) | welfare (I38) |
| money influences terms of trade in transactions (F31) | asset prices (G19) |
| money influences terms of trade in transactions (F31) | aggregate consumption (E20) |
| money influences terms of trade in transactions (F31) | investment (G31) |
| money influences terms of trade in transactions (F31) | output (C67) |
| money influences terms of trade in transactions (F31) | welfare (I38) |