Coexistence of money and interest-bearing bonds

Abstract

I construct a monetary model with agents that face idiosyncratic shocks to how they discount future utility. Once shocks are revealed, agents trade money for bonds in a financial market, then money for goods in a goods market, and finally move into the next time period. Away from the Friedman rule, money is scarce so that those who turn out to care little about the future, sell bonds at a discount to obtain money for immediate consumption—in the financial market, they reduce the savings value of their asset portfolio to obtain more liquid asset positions. This generates a net re-distribution of savings from agents that attach a low value to the future, to agents that attach a high value to the future. Ex-ante utility increases because losing savings when the future has low value, is dominated by receiving savings when the future has high value. The scarcity of money, however, leads to binding liquidity constraints in the goods market, which reduces ex-ante utility. The financial-market effect can dominate the goods-market effect, in which case the coexistence of money and interest-bearing bonds arises for an optimal policy.