Paper or Plastic ? Money and Credit as Means of Payment ∗

This paper studies the choice of payment instruments in a simple model where both money and credit can be used as means of payment. We endogenize the acceptability of credit by allowing retailers to invest in a costly record-keeping technology. Our framework captures the two-sided market interaction between consumers and retailers, leading to strategic complementarities that can generate multiple steady-state equilibria. In addition, limited commitment makes debt contracts self-enforcing and yields an endogenous upper bound on credit use. Our model can explain why the demand for credit declines as inflation falls, and how hold-up problems in technological adoption can prevent retailers from accepting credit as consumers continue to coordinate on cash usage. We show that whenever money and credit coexist, equilibrium is generically inefficient and optimal policy entails an inflation rate strictly above the Friedman rule. We also discuss the extent to which our model can reconcile some key patterns in the use of cash and credit in retail transactions.