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Title: The Limits of Monetary Economics: On Money as a Medium of Exchange in Near-Cashless Credit Economies

Author(s): Ricardo Lagos and Shengxing Zhang

Publication Date: October 2019

Keyword(s): asset prices, Cashless, credit, leverage, liquidity, margin and monetary policy

Programme Area(s): Financial Economics and Monetary Economics and Fluctuations

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.

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Bibliographic Reference

Lagos, R and Zhang, S. 2019. 'The Limits of Monetary Economics: On Money as a Medium of Exchange in Near-Cashless Credit Economies'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14057