Limited Commitment, Money, and Credit

This paper studies limited commitment and adverse selection in an economy in which private liabilities (inside money) can be used as instruments of intertemporal trade. The results suggest that in conjunction with adverse selection, the limited commitment problem may affect the behavior of intrinsically higher quality debtors more severely than lower quality ones. Nonetheless, a credit economy may function better when both problems are present than under limited commitment alone. Adding a fixed amount of money eases frictions associated with the credit market.