Modelling Money and Credit Demand

Study continues on the determinants of money and credit demand, and the institutions underpinning their supply and the enforceability of their property rights. Such study is undoubtedly more important than ever in order to understand our increasingly credit driven global economy. Recent events have certainly highlighted this fact as banks' fears of each other's insolvency contributed to the recent liquidity crisis.

Money and Credit: Communal Responsibility

Lars Boerner and CEP member Albrecht Ritschl study the institution of Communal Responsibility, practiced in medieval Europe, as a means of supporting the use of credit. As well as making an important contribution to the theory and economic history of the development of credit and money in Europe, this also allows them to draw parallels to modern institutions, in particular modern credit cards.

Communal responsibility was a means of enforcing payment via credit on anonymous transactions between people living in different areas. In this system, merchants would be held responsible outside their own city for the debts of their fellow citizens. So if one merchant from Vienna failed to pay a debt in Frankfurt, payment could be demanded from any Viennese merchant the next time they tried to trade in Frankfurt. The typical sanction was to take reprisals against the fellow citizens of a defaulting foreigner, be it through seizure of any goods or, if need be, outright imprisonment.

Boerner and Ritschl argue that communal responsibility was a surprisingly long lived institution, and provide micro evidence from the town of Linz in Austria during the early modern period. They document the arguments of town officials in favour of communal responsibility laws, arguing that they were absolutely necessary to guarantee that merchants paid their liabilities. They also document the support for the laws from merchants themselves: merchants from many countries signed a petition to the Emperor in support of communal responsibility legislation. They argue that this highlights the perceived benefits of the institution, especially from lowering transactions costs.

The authors provide theoretical justification for the prevalence of communal responsibility by presenting its impact on credit and money demand. They adapt the matching model of the demand for money and credit of Lagos & Wright (2005) to include communal responsibility in trade between villages. The novelty of their approach lies in the assumptions about enforceability of deferred payments. In the Lagos & Wright setup, such enforcement across villages is absent altogether. Anonymous random matching precludes individual reputation effects that might support the use of credit. Agents in cross-village trade would therefore be reduced to using money.

In Boerner and Ritschl's extension, although individual agents are anonymous their village of origin is known. This informational assumption opens room for communal responsibility as an enforcement technology. They show that the presence of village-specific reprisals leads to a welfare improvement and supports coexistence of money and credit in monetary search equilibrium.

To read more about Lars Boerner and Albrecht Ritschl's work on Modelling Money and Credit Demand see

• "Communal Responsibility and the Coexistence of Money and Credit Under Anonymous Matching" [Full document in Adobe PDF] (Lars Boerner and Albrecht Ritschl), CEP Discussion Paper 1034, December 2010