On Imperfect Competition with Occasionally Binding Cash-in-Advance Constraints

We provide extensive theoretical analysis of the general equilibrium of an economy with imperfect competition in the final goods sector, endogenous production and fully flexible prices in the presence of occasionally binding cash-in-advance (CIA) constraints, under general assumptions about the velocity of money. Whether the CIA constraint binds or not and the induced variability of the velocity of money depend on expectations of risk-averse consumers about the future relative value of money as well as the degree of imperfect competition. We establish the uniqueness of the equilibrium, the conditions under which money has real effects, even in the absence of other real assets, and examine the role of imperfect competition and welfare implications. With perfect foresight, in a zero-inflation steady state the CIA constraint strictly binds and output is less than would occur when the CIA constraint is non-binding. There is also an optimal negative steady-state inflation rate. Finally, we consider how the introduction of capital and bonds would fit into the framework.