This paper evaluates the importance of household credit in the transmission of monetary policy and in explaining the positive correlation between money and credit services over the business cycle. It does so in the context of a general equilibrium framework of cash and household credit with two distinguishing features. There is an explicit financial sector with firms specializing in the production of credit services. Second, the financial sector also contains financial intermediaries who provide interest bearing accounts for households and loanable funds to credit producers. It is shown that monetary injections in this set-up can generate a liquidity effect which positively influences the availability of household credit services and real activity. Furthermore, the model predicts that monetary injections actually lower the real cost of consumption, thus resolving a difficulty with recent liquidity effect models. The potential quantitative importance of this monetary transmission mechanism is analyzed.
https://doi.org/10.20955/wp.1998.019
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