The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
We develop a theory of money and credit as competing payment instruments, then put it to
work in applications. Buyers can use cash or credit, with the former (latter) subject to the
inflation tax (transaction costs). Frictions that make the choice of payment method interesting
also imply equilibrium price dispersion. We deliver closed-form solutions for money
demand. We then show the model can simultaneously account for the price-change facts,
cash-credit shares in micro payment data, and money-interest correlations in macro data. We
analyze the effects of inflation on welfare, price dispersion and markups. We also describe
nonstationary equilibria as self-fulfilling prophecies, which is standard, except here it entails
dynamics in the price distribution.