Money and Competing Means of Payment

In monetary theory, money is typically introduced as an object that can help agents bypass frictions, such as anonymity and limited commitment. Consequently, common wisdom suggests that if agents had access to more unsecured credit these frictions would become less severe and welfare would improve. In similar spirit, common wisdom suggests that as societies get access to more alternative (to money) payment instruments, i.e., more ways to bypass the aforementioned frictions, welfare would also increase. We show that for a large variety of settings and market structures this common wisdom is not accurate. If the alternative means of payment is sufficient to cover all the liquidity needs of the economy, then indeed the economy will reach maximum welfare. However, if access to this alternative payment system is relatively low to begin with, increasing it can hurt the economy’s welfare, and we characterize in detail the set of parameters for which this result can arise. Our model offers a simple explanation to a recent empirical literature suggesting that increased access to credit is often followed by declined economic activity.