Dynamic Indeterminacy and Welfare in Credit Economies

We characterize the set of dynamic equilibria of a pure credit economy with random matching and limited commitment. For standard trading mechanisms there are a continuum of steady states, a continuum of credit cycle equilibria of any periodicity, a subset of which yield a higher welfare than the ones singled out in the literature, and a continuum of sunspot equilibria. The set of equilibria expands as agents become more patient, trading opportunities are more frequent, and borrowers have more bargaining power. We characterize the constrained-e¢ cient allocations under both pairwise and centralized meetings, and we establish conditions under which the second welfare theorem of Alvarez and Jermann (2000) fails to apply to our economy, i.e., constrained-e¢ cient allocations cannot be implemented with not-too-tight solvency constraints.