Credit Market Frictions and Coessentiality of Money and Credit

Abstract

AbstractWe explore how credit market frictions matter for the coessentiality of money and credit. Limited commitment calls for credit limits that are tailored according to borrowers' productivity. Under an adverse selection problem caused by asymmetric information, however, lenders impose the credit limit of the low‐productivity borrower onto the high‐productivity borrower. If productivities differ sufficiently between borrowers, the high‐productivity borrower is credit‐constrained and is willing to hold money to compensate for the deficiency of their credit limit, whereas the low‐productivity borrower is not. This implies the coessentiality of money and credit in the sense that their simultaneous use improves welfare.