Money, Credit, and Allocation Under Complete Dynamic Contracts and Incomplete Markets

We construct a dynamic heterogeneous-agent model with random uninsurable endowments. Two allocation mechanisms are considered, one with longterm complete credit arrangements under private information, and one with incomplete competitive markets. A role for money arises due to random limited participation. A Friedman rule is optimal in the ...rst economy, and replicates a pure credit arrangement in the second. Computational results show that steady state allocations are quite di¤erent under the two arrangments, though the responses to changes in long-run in‡ation are similar. ¤Rao Aiyagari died suddenly in May 1997. Rao made important early contributions to the paper, but I bear full responsibility for the completed product. I have received useful comments and suggestions from seminar participants at Johns Hopkins University and the University of Texas at Austin.