Monetary Policy with Asset-Backed Money

Abstract

We study the use of asset-backed money in a neoclassical growth model with illiquid capital. A mechanism is delegated control of productive capital and issues claims against the revenue it earns. These claims constitute a form of asset-backed money. The mechanism determines (i) the number of claims outstanding, (ii) the dividends paid to claim holders, and (iii) the structure of redemption fees. We find that for capital-rich economies, the first-best allocation can be implemented and price stability is optimal. However, for sufficiently capital-poor economies, achieving the first-best allocation requires a strictly positive rate of inflation. In general, the minimum inflation necessary to implement the first-best allocation is above the Friedman rule and varies with capital wealth.