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On the Essentiality of Credit and Banking at Zero Interest Rates

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  • Paola Boel
  • Christopher J. Waller

Abstract

We investigate the welfare-increasing role of credit and banking at zero interest rates in a microfounded general equilibrium monetary model. Agents differ in their opportunity costs of holding money due to heterogeneous idiosyncratic time-preference shocks. Without banks, the constrained-efficient allocation is never attainable, since impatient agents always face a positive implicit rate in equilibrium. With banks, patient agents pin down the borrowing rate and in turn enable impatient agents to borrow at no cost when the inflation rate approaches the highest discount factor. Banks can therefore improve welfare at zero rates, provided that both types of agents are included in the financial system and that the borrowing limit is sufficiently lax. The result is robust to several extensions.

Suggested Citation

  • Paola Boel & Christopher J. Waller, 2023. "On the Essentiality of Credit and Banking at Zero Interest Rates," Working Papers 23-13, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwq:96203
    DOI: 10.26509/frbc-wp-202313
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    References listed on IDEAS

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    4. Robert A. Becker, 1980. "On the Long-Run Steady State in a Simple Dynamic Model of Equilibrium with Heterogeneous Households," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 95(2), pages 375-382.
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    More about this item

    Keywords

    Banking; Money; Zero Interest Rates;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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