On Default and Uniqueness of Monetary Equilibria

FEDS Working Paper No. 2015-034

http://dx.doi.org/10.17016/FEDS.2015.034

31 Pages Posted: 26 Jul 2015

See all articles by Li Lin

Li Lin

International Monetary Fund (IMF)

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System

Date Written: May 8, 2015

Abstract

We examine the role that credit risk in the central bank's monetary operations plays in the determination of the equilibrium price level and allocations. Our model features trade in fiat money, real assets and a monetary authority which injects money into the economy through short-term and long-term loans to agents. Short-term loans are riskless, but long-term loans are collateralized by a portfolio of real assets and are subject to credit risk. The private monetary wealth of individuals is zero, i.e., there is no outside money. When there is no default in equilibrium, there is indeterminacy. Positive default in every state of the world on some long-term loan endogenously creates positive liquid wealth that supports positive interest rates and resolves the aforementioned indeterminacy. Hence, a non-Ricardian policy across loan markets can determine the equilibrium allocations while it allows the central bank to earn profits from seigniorage in order to compensate for any losses.

Keywords: Collateral, Default, Determinacy, Liquid wealth, Monetary policy

JEL Classification: D5, E4, E5

Suggested Citation

Lin, Li and Tsomocos, Dimitrios P. and Vardoulakis, Alexandros, On Default and Uniqueness of Monetary Equilibria (May 8, 2015). FEDS Working Paper No. 2015-034, http://dx.doi.org/10.17016/FEDS.2015.034, Available at SSRN: https://ssrn.com/abstract=2612032 or http://dx.doi.org/10.2139/ssrn.2612032

Li Lin

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288 932 (Phone)
+44 1865 288 805 (Fax)

Alexandros Vardoulakis (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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