Monetary Policy and Alternative Means of Payment

19 Pages Posted: 29 Feb 2016 Last revised: 30 Nov 2016

Devika Hazra

California State University, Los Angeles

Date Written: November 14, 2016

Abstract

This paper captures the trade-offs between alternative payment instruments where each is associated with costs and benefits. Most models of cash-credit choice assume cash is a safe non-interest-bearing asset and credit is interest-bearing but costly. Here, I consider the risk of loss from using cash resulting from theft and foregone interest earnings. I use a cash-in-advance model to analyze the channel through which monetary policy could have a positive impact on the economy by altering the incentives for cash-credit choice. The model indicates that although expansionary monetary policy increases total consumption, the resulting substitution toward credit might increase transactions cost, which may not result in improving welfare. The net effect depends on the change in transactions cost of using credit relative to the responsiveness of theft to inflation. The assumption of fixed cost of credit is crucial to these results. Calibration of the model to the US and Polish economy confirms the results.

Keywords: cash-credit choice, monetary policy, means of payment

JEL Classification: E5

Suggested Citation

Hazra, Devika, Monetary Policy and Alternative Means of Payment (November 14, 2016). Quarterly Review of Economics and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2738707

Devika Hazra (Contact Author)

California State University, Los Angeles ( email )

5151 State University Dr
Los Angeles, CA 90032
United States

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