Working Paper, Brown University, Department of Economics 2001-22
Money, which provides liquidity, is distinct from debt. The introduction of a bank that issues money in exchange for debt and pays out its profit as dividend to shareholders modifies the model of overlapping generations. Monetary policy can set, alternatively, the nominal rate of interest or the circulation of real balances. The set of equilibrium paths, their dynamic properties, as well as the scope and effectiveness of monetary policy are significantly altered: (1) there is a continuum of Pareto comparable steady state paths, indexed by the nominal rate of interest; (2) for a set level of real balances, the associated steady state may be stable or unstable, but cyclical uctuations do not arise; and, (3) though low rates of interest are associated with superior steady state allocations, they may account for unstable steady states or stable endogenous cycles.