We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with money and nominal government bonds, but all trades must be monetary. We demonstrate that a deflationary policy àlaFriedman cannot sustain the constrainedefficient allocation as no-arbitrage imposes too stringent a bound on the return money can pay. The constrained-efficient allocation can be sustained when bonds have positive yields and, under certain conditions, only if they are illiquid. Illiquidity, meaning that bonds cannot be transformed into consumption as easily as cash, is necessary to eliminate arbitrage opportunities due to disparities in shadow interest rates.

this version: 2003 The primary question that I try to address here is: Why do government-issued, nominal bonds not circulate as a medium of exchange, while money does? A related question is: Why are such bonds sold for money at a discount, even if they bear no default risk? In the process of answering these questions, I integrate the microfoundation of monetary theory with the influential work of Lucas (1990). I examine two models of this integrated framework. In the first model, the government does not participate in the goods market. Then, there are a continuum of monetary equilibria where matured bonds circulate in the goods market as perfect substitutes for money. In the second model, the government participates in the goods market and accepts only money as payments for its goods, while private agents can trade among themselves using both money and bonds. This model has a unique equilibrium, and an arbitrarily small measure of government sellers is sufficient to drive matured bonds out of the circulation. In both models, newly issued bonds are sold at a discount for money and thus they bear positive interest. The effects of monetary policy differ in these two economies, some of which contrast sharply with the effects in traditional models.

This paper presents an integrated theory of money and banking. I address the following question: when both individuals and banks have private information, what is the optimal way to settle debts? I develop a dynamic model with micro-founded roles for banks and a medium of exchange. I establish two main results: rst, markets can improve upon the optimal dynamic contract at the presence of private information. Market prices fully reveal the aggregate states and help solve the incentive problem of the bank. Secondly, it is optimal for the bank to require loans be settled with short-term inside money, i.e. bank money that expires immediately after the settlement of debts. Short-term inside money dominates outside money because the former makes it less costly to induce truthful revelation and achieve more e ¢ cient risk sharing. Key words: banking, inside money, outside money JEL classi…cations: E4, G2 I am grateful to Shouyong Shi for guidance and inspiration. I thank David Mills for insightful comments and suggestions. I have also bene…ted from conversations with seminar participants at the

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of last resort operations in the mid-19 th century

This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. Repo Runs

An example is constructed to illustrate some points about the Berentsen-Camera-Waller article, followed by some comments. 1.

This paper studies the choice of payment instruments in a simple model where both money and credit can be used as means of payment. We endogenize the acceptability of credit by allowing retailers to invest in a costly record-keeping technology. Our framework captures the two-sided market interaction between consumers and retailers, leading to strategic complemen-tarities that can generate multiple steady-state equilibria. In addition, limited commitment makes debt contracts self-enforcing and yields an endogenous upper bound on credit use. Our model can explain why the demand for credit declines as inflation falls, and how hold-up prob-lems in technological adoption can prevent retailers from accepting credit as consumers continue to coordinate on cash usage. We show that whenever money and credit coexist, equilibrium is generically inefficient and optimal policy entails an inflation rate strictly above the Friedman rule. We also discuss the extent to which our model can reconcile some key patterns in the use of cash and credit in retail transactions.

This paper presents an integrated theory of money and dynamic credit. I study nancial intermediation when both the intermediary and individuals have private information. I show that money is essential in solving the two-sided incen-tive problems under the dynamic credit arrangement. First, requiring settlement with money can induce market trades that generate information-revealing prices to discipline the intermediary. Second, it is optimal for the intermediary to issue money that can record its own history of being used in settlements, and to require settlements be made with only money that has been returned to the intermedi-ary every settlement period. This arrangement e¤ectively reduces individuals incentives to deviate and allows intermediation to achieve e ¢ cient allocations. Key words: private money; dynamic credit JEL classi…cations: E4, G2 A previous version of this paper was circulated under the title Banking, Inside Money and Outside Money(Sun, 2007b). I am grateful to Shouyong Shi for guidance and inspiration. I thank an anony-mous referee for insightful comments and suggestions. I have also bene…ted from conversations with

A dynamic general-equilibrium model with limited participation in financial markets is constructed to study the determination of nominal exchange rates in a small open economy with tradable and non-tradable goods. The qualitative and quantitative implications of this framework are assessed under flexible prices. Then, the panel dynamic OLS regression is applied to seek the empirical support for this liquidity-exchange rate model, a slight departure from the standard monetary-exchange rate model. The findings in the present paper shed light on the cointegration between the macroeconomic fundamentals and nominal exchange rates.