Welfare-Improving Credit Controls

Credit controls are generally believed to result in an inefficient allocation of resources. This paper presents a counterexample. It displays a general equilibrium, multi-good model with spatial separation for which steady state equilibria exist in which both cash (i.e. fiat currency) and trade credit are used in exchange. Transaction costs, restrictions on the timing of trade, and a positive nominal interest rate cause the laissez-faire equilibrium to be non-optimal. A quantitative restriction on the use of trade credit can yield a Pareto superior allocation.