Economic Theory

, Volume 62, Issue 1–2, pp 245–264

On default and uniqueness of monetary equilibria

  • Li Lin
  • Dimitrios P. Tsomocos
  • Alexandros P. Vardoulakis
Research Article

DOI: 10.1007/s00199-015-0890-y

Cite this article as:
Lin, L., Tsomocos, D.P. & Vardoulakis, A.P. Econ Theory (2016) 62: 245. doi:10.1007/s00199-015-0890-y


We examine the role that credit risk in the central bank’s monetary operations plays in the determination of the equilibrium price level and allocations. Our model features trade in fiat money, real assets and a monetary authority which injects money into the economy through short-term and long-term loans to agents. Short-term loans are riskless, but long-term loans are collateralized by a portfolio of real assets and are subject to credit risk. The private monetary wealth of individuals is zero, i.e., there is no outside money. When there is no default in equilibrium, there is indeterminacy. Positive default in every state of the world on some long-term loan endogenously creates positive liquid wealth that supports positive interest rates and resolves the aforementioned indeterminacy. Hence, a non-Ricardian policy across loan markets can determine the equilibrium allocations, while it allows the central bank to earn profits from seigniorage in order to compensate for any losses.


Determinacy Liquid wealth Default Collateral Monetary policy 

JEL Classifications

D5 E4 E5 

Copyright information

© Springer-Verlag Berlin Heidelberg (Outside the USA) 2015

Authors and Affiliations

  • Li Lin
    • 1
  • Dimitrios P. Tsomocos
    • 2
  • Alexandros P. Vardoulakis
    • 3
  1. 1.International Monetary FundWashingtonUSA
  2. 2.Saïd Business School and St. Edmund HallUniversity of OxfordOxfordUK
  3. 3.Board of Governors of the Federal Reserve SystemWashingtonUSA

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