Debt Constraints and Monetary Policy

In the present paper we show how simple monetary policies can mitigate real effects of credit frictions. We consider stationary overlapping generations economies in which consumers are not equally efficient in producing... [ view full abstract ]

In the present paper we show how simple monetary policies can mitigate real effects of credit frictions. We consider stationary overlapping generations economies in which consumers are not equally efficient in producing capital and cannot commit to repay loans. At real equilibria, both less productive and more productive consumers engage in capital production. At monetary equilibria consumers can hold money instead of engaging in capital production. Money in itself does not mitigate the real effects of credit frictions and equilibrium allocations are generally not Pareto optimal. However printing money and distributing them to young consumers increase their incomes allowing young more productive consumers to produce more capital. Thereby output is increased.