Coexistence of Money and Interest-Bearing Bonds

This paper revisits how coexistence of money and bonds can make a society better off. For this purpose, a model is constructed in which payment instruments matter for settling real transactions and savings instruments matter because agents differ in how they discount future utility. Because bonds and money differ in their characteristics as payment and savings instruments, the model is able to explain the coexistence puzzle for an optimally chosen monetary policy. Such a policy trades-offs efficiency in financial markets, in which money is traded for bonds, with efficiency in goods markets, in which money is traded for a real good. Financial markets can achieve a better distribution of savings when agents are constrained by their money holdings, but this is bad for efficiency in goods markets. The former effect can dominate the latter so that optimal policy deviates from the Friedman rule.