Money, Credit, and Opportunity Costs

A cash-in-advance model of multiple means of payment is constructed to study the coexistence of multiple means of payment and the effects of opportunity costs and monetary policy. In steady state equilibrium, if the opportunity cost of credit, transactions cost, increases, people hold more cash and use it for a greater variety of goods. Next, if the money growth rate decreases, then the opportunity cost of money, the nominal interest rate, decreases and people use cash for a greater variety of goods. To improve welfare, the government needs to decrease the money stock in order to avoid opportunity costs and the Friedman rule is optimal.