Money and credit in liquidity provision

This paper studies the liquidity provision in a model where the roles of money are challenged by other financial instruments. Alternative to money, credit can be used as means of payment and rate dominating assets are available to serve as stores of value. Two features are found to be crucial in rendering money valuable in this environment: information asymmetry in credit trading relationship and uncertainty in individuals' liquidity demand. In general, the model economy can display a payment mechanism of money-only, credit-only, or mixed-use of money and credit in transactions, depending on the severity of the information asymmetry. The optimal quantity of money in our paper is shown to contrast those in other monetary models. © 2001 Elsevier Science B.V.