Creative Destruction with Credit Inflation

We model creative destruction as a channel via which credit inflation affects growth. With a demand function for real credit, there is a dynamically consistent revenue-maximizing rate of credit inflation. A higher semi-elasticity of real credit demand with respect to credit inflation yields a lower rate of credit inflation and lower revenue from credit inflation shared by the banks and the entrepreneurs. The revenue to entrepreneurship attracts more resources into R&D, promoting growth. The revenue to banks attracts more labor into intermediaries, decreasing the monopolistic profit of innovations. When the bargaining share of the banks is low, the former effect dominates and credit inflation promotes growth; when it is high, the latter effect dominates and credit inflation retards growth.