We argue that the introduction and widespread use of credit cards increases trading efficiency but must cause a massive increase in price levels, other things being equal. Government monetary intervention sufficient to stop these price increases must necessarily undo all the efficiency gains that credit cards bring. Things are worse if there is default on credit cards: large price increases are inevitable unless the monetary authority is willing to engineer substantial reductions in trading efficiency.
In modern economies, more and more transactions take place via credit cards. They are perhaps the single most visible and talked about economic innovation in the last 40 years. Yet credit cards have not been extensively studied by general equilibrium theorists or monetary theorists, presumably because it has been thought that the effects of credit cards are negligible, or easily managed by monetary interventions. Insofar as they are mentioned in the modern economics curriculum at all, it is only in the context of calibrating the rationality of consumers, or lamenting the indebtedness of the household sector. The efficiency gains they bring, and their effect on price levels, have been ignored. An older macroeconomic literature in the 1950s and 60s did raise these issues about "near monies", but this was before the advent of credit cards, in an intellectual era of reduced form models in which it would have been impossible to directly analyze credit cards anyway.
We introduce a one-period general equilibrium model with money and credit cards in which individual agents choose whether to buy goods with cash or credit cards, and prices adjust in order to clear all markets. No assumptions are needed on the number of commodities or the form of the utilities (beyond the usual general equilibrium hypotheses of continuity and concavity). We show in a series of theorems that a widespread use of credit cards must have a profound effect on price levels in the absence of monetary interventions, and that policy interventions to prevent price increases can be problematic. We do not deal with the transition from the regime without credit cards to the new regime with credit cards, preferring to keep the analysis as simple as possible by restricting ourselves in this paper to a one-period model. In a dynamic economy we would expect to see several periods of rapid inflation after credit cards are introduced, tapering off only when prices settle down at much higher levels.
The surge in price levels in the United States in the 1970s and early 1980s coincided with the introduction of credit cards. Though we are in no position at this time to make an empirical connection between credit cards and the stagflation in the 1970s and early 80s, our model provides a theoretical possibility of a causal connection. Many countries have introduced credit cards at different times over the past 30 years, with differing levels of default. In future work we hope to take advantage of this data to provide an empirical test of the theoretical conclusions we derive here.
The paper is organized as follows. In Section 1 we recall the one-period general equilibrium monetary economy that we ourselves introduced (Dubey-Geanakoplos (1992), (2003)). We could probably have studied credit cards in other monetary general equilibrium models, but ours appears to be the simplest. Our model embodies the distinction Gurley and Shaw emphasized between inside and outside money; this distinction is crucial to the existence of a positive value of money in a one-period economy. Theorem 1 reprises our old observation that monetary equilibrium does exist if there are enough gains to trade available from the initial endowment. The model also displays in rudimentary form the trade-off the monetary authority faces between efficiency and inflation.
Credit cards are introduced in Section 2, and for simplicity, we first examine the idealized situation where default does not occur. Consumers choose whether to buy goods with cash or credit cards. Naturally they find it more convenient to use credit cards, raising the question whether money can survive. Indeed many commentators refer to the coming “cashless” economy in which the supply of inside and outside money (i.e., cash) will be irrelevant. It is tempting to think that if credit cards became available to all households for the purchase of all commodities, and if there were no credit limits, then virtually all transactions would be conducted via credit cards, eventually eliminating the use of money altogether. These conclusions depend on how credit cards are settled. In the natural case, corresponding roughly to the situation faced by the typical consumer today (in 2008), credit card debts and receipts are not “netted.” A consumer who gets his credit card bill must find the cash to pay, perhaps by writing a check on his bank account or paying with a debit card. He cannot point out that as a merchant he has sold goods to customers charged on their credit cards, who owe him as much money as he himself owes. Without netting, credit cards do not alleviate the need for money, they only postpone it. Thus without netting we are able to show quite generally in Theorem 2 that money remains viable, i.e. that an equilibrium exists in which money has positive (albeit diminished) value.
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