The Societal Benefits of Money and Interest Bearing Debt
32 Pages Posted: 19 Feb 2019
Date Written: February 6, 2019
A long standing issue in monetary theory is whether money and interest bearing debt may both play a beneficial role in facilitating transactions. This paper identifies in the misallocation of liquidity a key element to provide an answer. In a search model of money, we show that there exists an equilibrium which resembles a liquidity trap, in which debt and money are used interchangeably to trade goods and debt carries no interest, and a Pareto superior equilibrium in which money is used to trade goods and interest bearing debt to reshuffle misallocated liquidity. Monetary policy has no effect in the liquidity trap, and a liquidity effect in the Pareto superior equilibrium.
Keywords: Money, Debt, Bonds, Monetary Policy
JEL Classification: E40
Suggested Citation: Suggested Citation