We argue that monetary factors such as the nominal interest rate, might be important for understanding this phenomenon through a working capital channel. We show that in a limited participation model where firms borrow from banks to finance working capital, a positive money supply shock drives the nominal interest rate down, thereby stimulating firms' borrowing and causing employment to rise. Since all sectors of the economy are subject to the same effect, comovement arises naturally. Furthermore, a positive aggregate technology shock drives the nominal interest rate down upon impact and induces comovement when the elasticity of labor supply is large. We study the coexistence of monetary and credit transactions in a model where exchange is decentralized.
Agents belong to different villages that are informationally separated.
The frequency of meetings between any two different villages decreases in their respective geographic distance. The equilibrium mix of monetary and credit transactions i s characterized as a function of the frequency of meetings among agents from different villages. Our economy may be interpreted as a medieval economy. Trade takes place only among a small set of nearby villages via the use of credit. Monetary trades emerge only after transactions with faraway villages become sufficiently frequent.