Money and credit with limited commitment and theft

We study the interplay among imperfect memory, limited commitment, and theft, in an environment that can support monetary exchange and credit. Imperfect memory makes money useful, but it also permits theft to go undetected, and therefore provides lucrative opportunities for thieves. Limited commitment constrains credit arrangements, and the constraints tend to tighten with imperfect memory, as this mitigates punishment for bad behavior in the credit market. Theft matters for optimal monetary policy, but at the optimum theft will not be observed in the model. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls. ∗We thank Randy Wright for his input during the early stages of this project, and Narayana Kocherlakota for helpful comments. The comments and suggestions of seminar and conference participants at the University of Maryland, the University of Toronto, the Federal Reserve Bank of New York, and the Midwest Macro Meetings 2008 were very helpful. Sanches thanks the Center for Research in Economics and Strategy at Washington University for financial support.