The Model

Analytical Solution
Velocity of Money
Discussion

A CIA model with cash and credit goods

Morten Inés Ramiro

Monetary Policy, 2010

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Outline

1 The Model

2 Analytical Solution

3 Velocity of Money

4 Discussion

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

The Model

This is a CIA type model.

There are two types of goods, cash and credit goods

Cash goods can only be purchased with some of the resources

available

Credit goods can be bought with all the resources

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

The Model

This is a CIA type model.

There are two types of goods, cash and credit goods

Cash goods can only be purchased with some of the resources

available

Credit goods can be bought with all the resources

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

The Model

This is a CIA type model.

There are two types of goods, cash and credit goods

Cash goods can only be purchased with some of the resources

available

Credit goods can be bought with all the resources

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

The Model

This is a CIA type model.

There are two types of goods, cash and credit goods

Cash goods can only be purchased with some of the resources

available

Credit goods can be bought with all the resources

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

So The Constraints are:

CIA constraint

pt c1t + Bt ≤ Mt −1 + (1 + it −1 )Bt −1

This means timing is as follows:

The agent enters period t with nancial wealth, which can be

used to purchase nominal bonds Bt or carried as cash into the
goods market in order to consume.

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

So The Constraints are:

CIA constraint

pt c1t + Bt ≤ Mt −1 + (1 + it −1 )Bt −1

This means timing is as follows:

The agent enters period t with nancial wealth, which can be

used to purchase nominal bonds Bt or carried as cash into the
goods market in order to consume.

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Budget Constraint

Budget constraint

pt c1t + pt c2t + Mt + Bt ≤ pt wt ht + Mt −1 + (1 + it −1 )Bt −1

Notice both types of goods have the same price.

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 The Model
Analytical Solution
Velocity of Money
Discussion

Role of ination.

Budget constraint in Real terms

mt −1 + (1 + it −1 )bt −1
c1t + c2t + mt + bt ≤ wt ht +
1 + πt

Where mt = Mt /pt , bt = Bt /pr , pt = (1 + πt )pt −1

Ination is costly to the consumer

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 The Model
Analytical Solution
Velocity of Money
Discussion

Role of ination.

Budget constraint in Real terms

mt −1 + (1 + it −1 )bt −1
c1t + c2t + mt + bt ≤ wt ht +
1 + πt

Where mt = Mt /pt , bt = Bt /pr , pt = (1 + πt )pt −1

Ination is costly to the consumer

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 The Model
Analytical Solution
Velocity of Money
Discussion

Opportunity Cost Of Money

Money has an opportunity cost

i
(1 + π)(1 + r )

i
≈
1+ i
Opportunity cost increases as the nominal rate increase

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 The Model
Analytical Solution
Velocity of Money
Discussion

Opportunity Cost Of Money

Money has an opportunity cost

i
(1 + π)(1 + r )

i
≈
1+ i
Opportunity cost increases as the nominal rate increase

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Opportunity Cost Of Money

Money has an opportunity cost

i
(1 + π)(1 + r )

i
≈
1+ i
Opportunity cost increases as the nominal rate increase

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

The Consumer Program.

The Consumer Program

∞
max ∑ β t {α ln c1t + (1 − α) ln c2t − γ ht }
c1t ,c2t ,mt ,bt ,ht t =0

Subject to

mt −1 + (1 + it −1 )bt −1
c1t + c2t + mt + bt ≤ wt ht + (λt )
1 + πt

mt −1 + (1 + it −1 )bt −1
c1t + bt ≤ (µt )
1 + πt

ht ≥ 0 (ηt )

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

The Consumer Program.

The Consumer Program

∞
max ∑ β t {α ln c1t + (1 − α) ln c2t − γ ht }
c1t ,c2t ,mt ,bt ,ht t =0

Subject to

mt −1 + (1 + it −1 )bt −1
c1t + c2t + mt + bt ≤ wt ht + (λt )
1 + πt

mt −1 + (1 + it −1 )bt −1
c1t + bt ≤ (µt )
1 + πt

ht ≥ 0 (ηt )

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 The Model
Analytical Solution
Velocity of Money
Discussion

First Order Conditions

c1t :
α
= λt + µt
c1t
c2t :
1−α
= λt
c2t
Condition for c2 implies λt > 0 or budget constraint is binding.
If µt = 0 then would have

Uc1t = Uc2t

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 The Model
Analytical Solution
Velocity of Money
Discussion

First Order Conditions

c1t :
α
= λt + µt
c1t
c2t :
1−α
= λt
c2t
Condition for c2 implies λt > 0 or budget constraint is binding.
If µt = 0 then would have

Uc1t = Uc2t

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

First Order Conditions

c1t :
α
= λt + µt
c1t
c2t :
1−α
= λt
c2t
Condition for c2 implies λt > 0 or budget constraint is binding.
If µt = 0 then would have

Uc1t = Uc2t

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

bt :
1+ it
λt + µt = β [λt +1 + µt +1 ]
1 + πt +1

mt :
β
λt = [λt +1 + µt +1 ]
1 + πt +1

λ t + µt
⇒ λt = =⇒ λt ≤ λt + µt
1 + it

it > 0 =⇒ µt > 0 and Uc2t < Uc1t

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 The Model
Analytical Solution
Velocity of Money
Discussion

bt :
1+ it
λt + µt = β [λt +1 + µt +1 ]
1 + πt +1

mt :
β
λt = [λt +1 + µt +1 ]
1 + πt +1

λ t + µt
⇒ λt = =⇒ λt ≤ λt + µt
1 + it

it > 0 =⇒ µt > 0 and Uc2t < Uc1t

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 The Model
Analytical Solution
Velocity of Money
Discussion

Proportion Of Consumption

Consumption

c1t α 1 Uc2t 1
= or =
c2t 1 − α 1 + it Uc1t 1 + it

So the CIA requirement is acting as a tax rate of size it .

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 The Model
Analytical Solution
Velocity of Money
Discussion

Steady State

Remmber F.O.C for bonds:

1+ it
λt + µt = β [λt +1 + µt +1 ]
1 + πt +1

At steady state 1/β = 1 + r ss so

i ≈ π + 1/β − 1.

In the long run we recover Fisher relationship: nominal interest

rate moves one for one with variations in the rate of ination

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Steady State

Remmber F.O.C for bonds:

1+ it
λt + µt = β [λt +1 + µt +1 ]
1 + πt +1

At steady state 1/β = 1 + r ss so

i ≈ π + 1/β − 1.

In the long run we recover Fisher relationship: nominal interest

rate moves one for one with variations in the rate of ination

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Steady State

Remmber F.O.C for bonds:

1+ it
λt + µt = β [λt +1 + µt +1 ]
1 + πt +1

At steady state 1/β = 1 + r ss so

i ≈ π + 1/β − 1.

In the long run we recover Fisher relationship: nominal interest

rate moves one for one with variations in the rate of ination

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Velocity Of Money

Since there is no capital in this economy, total transactions are

given by total consumption ct = c1t + c2t .
Velocity of money:

v = Pt ct /Mt = ct /mt

Proportion of cash goods in total consumption

c1t α
=
c1t + c2t 1 + (1 − α)it

But because of opportunity cost mt = c1t , therefore

ct 1 + (1 − α)it
v= =
mt α

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Velocity Of Money

Since there is no capital in this economy, total transactions are

given by total consumption ct = c1t + c2t .
Velocity of money:

v = Pt ct /Mt = ct /mt

Proportion of cash goods in total consumption

c1t α
=
c1t + c2t 1 + (1 − α)it

But because of opportunity cost mt = c1t , therefore

ct 1 + (1 − α)it
v= =
mt α

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Velocity Of Money

Since there is no capital in this economy, total transactions are

given by total consumption ct = c1t + c2t .
Velocity of money:

v = Pt ct /Mt = ct /mt

Proportion of cash goods in total consumption

c1t α
=
c1t + c2t 1 + (1 − α)it

But because of opportunity cost mt = c1t , therefore

ct 1 + (1 − α)it
v= =
mt α

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Discussion

Velocity of money is variable. A realistic feature that classic

CIA doesn't capture.

Velocity increases with interest rates because of substitution

eect.

Other properties remain as in the standard CIA model.

Hard to implement. Separation between goods is exogenous,

there is no evident framework for production technology.

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Discussion

Velocity of money is variable. A realistic feature that classic

CIA doesn't capture.

Velocity increases with interest rates because of substitution

eect.

Other properties remain as in the standard CIA model.

Hard to implement. Separation between goods is exogenous,

there is no evident framework for production technology.

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Discussion

Velocity of money is variable. A realistic feature that classic

CIA doesn't capture.

Velocity increases with interest rates because of substitution

eect.

Other properties remain as in the standard CIA model.

Hard to implement. Separation between goods is exogenous,

there is no evident framework for production technology.

IDEA - QEM Universitat Autònoma de Barcelona

 The Model
Analytical Solution
Velocity of Money
Discussion

Discussion

Velocity of money is variable. A realistic feature that classic

CIA doesn't capture.

Velocity increases with interest rates because of substitution

eect.

Other properties remain as in the standard CIA model.

Hard to implement. Separation between goods is exogenous,

there is no evident framework for production technology.

IDEA - QEM Universitat Autònoma de Barcelona