Money, Credit and Banking

In many situations, some people hold large money balances but have no particular urgency to spend them while others are liquidity constrained. This problem creates a role for financial intermediaries who accept nominal deposits and make nominal loans. We show that financial intermediation improves the allocation away from the Friedman rule. The gains in welfare come from the payment of interest on deposits and not from relaxing borrowers' liquidity constraints. We also demonstrate that increasing the rate of inflation can be welfare improving when credit rationing occurs