Money and Finance with Costly Commitment

Supersedes Working Paper 94-25 – Money and Finance in a Model of Costly Commitment

Specifically, expenditure on financial services is necessary to ensure commitment. When commitment is costless, the equilibrium allocation is equivalent to that from an Arrow sequential markets equilibrium. When commitment is prohibitively expensive, the allocation is similar to the Townsend equilibrium. The authors use numerical examples to study the consequences of costly commitment for coexistence of money and credit, asset pricing, welfare implications of currency and variations in its growth rate, and the relationships between income and financial development.