Strategic Debt in a Monetary Economy

Producers can leverage their bargaining power vis-à-vis consumers by entering bargaining with debt. We discover novel general-equilibrium effects of such strategic debt by developing a money-search framework featuring heterogeneous consumers. Debt distorts trade along two margins: it destroys matches with low-preference consumers and it tightens liquidity constraints within matches. While the fiscal authority can fully eliminate strategic debt through taxation, in its absence, monetary policy can partially curb it by deviating from the Friedman rule—raising nominal rates up until 0.51%. Finally, we show that producers can leverage their bargaining power even more effectively with contracts different from debt.