Credit Market Frictions and Coessentiality of Money and Credit

Abstract

We explore how credit market frictions matter for the coessentiality of money and credit. There are high-productivity and low-productivity borrowers. Limited commitment can yield a one-for-one credit limit in accordance with a borrower's productivity. An adverse selection problem caused by asymmetric information, however, makes lenders impose the credit limit of a low-productivity borrower on a high-productivity borrower. If productivities differ sufficiently between borrowers, a high-productivity borrower is credit-constrained and is willing to hold money to compensate for the deficiency of their credit limit, but a low-productivity borrower is not. This eventually implies the coessentiality of money and credit in the sense that the use of both improves the allocation from a social welfare perspective.