Working Paper: NBER ID: w25803
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: monetary policy; credit economies; medium of exchange; asset prices; economic welfare
JEL Codes: E31; E4; E41; E42; E43; E44; E5; E51; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| money (E42) | monetary policy effects on asset prices (E52) |
| money (E42) | aggregate economic outcomes (E10) |
| traditional models excluding money (E19) | inadequate for capturing dynamics of monetary policy (E19) |
| cashless limit of monetary equilibrium (E42) | does not correspond to equilibrium of non-monetary economy (D59) |
| existence of money (E42) | influences terms of trade in credit transactions (E43) |
| influence of money on terms of trade (F14) | feedback loop affecting asset prices (G19) |
| influence of money on terms of trade (F14) | feedback loop affecting overall economic welfare (D69) |
| monetary policy effects (E52) | substantial even as aggregate real balances approach zero (E19) |