Risk, Inside Money, and the Real Economy

In modern economies, most money takes the form of inside money; deposits created by commercial banks to fund credit extension. Because is used as a payment instrument, doubts about risks associated with extension can affect aggregate outcomes. This paper constructs and analyzes model risky extension, creation, monetary exchange. When sufficiently risky, positive probability bank default arises this affects return characteristics money. Depositors then demand risk premium for holding money, which drives wedge between bankers' funding costs social benefits creation. negatively output, welfare. A government restore efficiency swapping risk-free forms debt.