Money and Dynamic Arrangements with Private Information

We construct a model with private information in which consumers write dynamic contracts with financial intermediaries. A role for money arises due to random limited participation of consumers in the financial market. Without defection constraints, a Friedman rule is optimal, the mean and variability of wealth tend to fall in the steady state, and the welfare effects of inflation are very small. With defection constraints, the effects of inflation on the distribution of welfare and consumption are large, but the effect on average welfare is still small. Also, the relaxation of defection constraints resulting from higher inflation causes a substantial increase in the real interest rate.