Transaction costs and the use of cash and credit

Summary An overlapping generations model with spatial separation and transaction costs is developed that displays steady state equilibria in which both cash (fiat currency) and trade credit are used in exchange. Equilibria in which trade credit is used are not Pareto optimal. The question of the optimal quantity of money is addressed. Deflation is found to be optimal, contrary to the result for standard overlapping generations environments.This paper is based upon my dissertation, written for the University of Minnesota. I am grateful to Kathryn Combs, Michael Dotsey, Bruce Horning, Anne Villamil and seminar participants at numerous institutions for helpful comments. Most of all, I want to thank my advisor, Neil Wallace, for the attention he gave to my work. The views expressed in this paper are solely those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Richmond or the Federal Reserve System.