Entrepreneurial Finance, Home Equity, and Monetary Policy

Abstract

We model entrepreneurial finance using a combination of fiat money, credit cards, traditional bank loans, and home equity loans. The banking sector is over-the-counter, where bargaining determines the pass-through from the nominal interest rate to the bank lending rate, characterizing the transmission channel of monetary policy. The strength of this channel depends on the combination of nominal and real assets used to finance investments, and declines in the extent to which housing is accepted as collateral. Optimal investment occurs for a range of positive nominal interest rates due to strategic motives of holding fiat money. An extension shows that said motives vanish with access to competitive financial markets, rendering only the Friedman rule optimal. To address inefficiencies in a high interest rate environment, unconventional policy introducing partially liquid bonds relaxes entrepreneurs' liquidity constraints and restores efficiency.