Welfare-improving debt constraints

We show that in economies without liquidity frictions, but with incomplete financial markets, when agents are infinitely lived and uniformly impatient, money can still be essential (that is, have a positive price in equilibrium) if and only if each agent has binding debt constraints at some node of her life span. That is, contrary to what might be expected, in the absence of a very productive financial market, frictions induced by debt constraints create some room for improving efficiency, by allowing money to have a role in transferring wealth across dates and states of nature.