DP14057 The Limits of Monetary Economics: On Money as a Medium of Exchange in Near-Cashless Credit Economies

Author(s):	Ricardo Lagos, Shengxing Zhang
Publication Date:	October 2019
Keyword(s):	asset prices, Cashless, credit, leverage, liquidity, margin, monetary policy
JEL(s):	D83, E52, G12
Programme Areas:	Financial Economics, Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=14057

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.