The Welfare Effect of Access to Credit
Rojas Breu, Mariana, Economic Inquiry
In modern economies, two types of money are widely used: outside money (i.e., notes and coins issued by central banks) and inside money issued by commercial banks (e.g., checks or credit cards). Transactions do not only differ in the monetary instrument used: Whereas some of them involve a credit operation, like those carried out with credit cards, others require the acquisition of money balances prior to the transaction. Over the last few decades, major changes have occurred in consumer methods of payments, owing to a large extent to technological improvements which have substantially altered the convenience of using plastic money as opposed to paper money. In particular, the relative importance of transactions conducted with credit cards has increased compared to transactions in which no credit is granted. Although at the beginning of the 1970s all general-purpose payment cards (including credit cards) only accounted for less than 2% of the volume of all consumer expenditures, in the late 2000s about one-fifth of the expenditures were settled with credit cards. Factors like the reduction in the time to process credit-card transactions, the decline in the cost of telecommunications, or the enhancement of bank techniques for screening and monitoring an increasing number of customers are crucial in explaining the observed rise in the share of credit transactions. (1)
However, outside money is still extensively used. For instance, in 2008 in the United States, payments in cash accounted for 20.9% of the volume of consumer transactions and 33.7% of the number of consumer transactions. (2) This observation suggests that credit is not available in numerous circumstances and hence that participation in the credit markets is limited) The estimation by the Survey of Consumer Finances (SCF) that 27.3% of U.S. households did not have a general-purpose bank-type credit card in 2001 is further evidence of limited participation in credit markets.
In this article, I study the welfare implications of the increased use of credit as a means of payment in the presence of limited participation in the credit market. In particular, my analysis concerns the extension of intra-period credit associated with the purchase of goods and services, usually referred to as convenience credit, in a full-enforcement set-up with ex ante identical agents. (4) For this, I build a microfounded monetary model a la Lagos and Wright (2005) in which agents can use both credit issued by financial intermediaries and outside money as media of exchange. (5) The model presented captures the main feature that distinguishes intra-period credit from money: While credit allows delaying settlement if an opportunity of consumption arises, money balances must be held in advance to settle a transaction and therefore are exposed to inflation. To study an economy with limited participation in the credit market, I assume that the use of bank credit in trade depends upon the availability of a technology: for example, credit cards can only be used if a card reader is available. This technology determines the number of transactions that can be settled with credit every period. As agents face uncertainty regarding their ability to use credit, a precautionary demand for money emerges endogenously.
In this model, inflation deteriorates welfare by two channels. First, as is usual in monetary models, inflation reduces lifetime consumption by increasing the marginal cost of holding money. In addition, inflation negatively affects welfare because it makes consumption-risk sharing less efficient. As it reduces consumption by agents in periods in which they cannot borrow and increases consumption by agents when they are able to use credit, agents are less able to smooth consumption across periods.
The model presented is suitable for studying the consequences of a technological improvement in the credit sector which allows agents to resort to intra-period credit more often and thereby gives rise to a higher share of credit transactions. …