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Why fiat money is a safe asset

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  • Paulsen, Dirk
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    Abstract

    This paper presents a model in which (1) fiat money has strictly positive value in the unique trembling hand equilibrium. This holds as each bank note is both: (a) a witness for the existence of some agent in the economy with debt, backed by collateral, and (b) the only matter that allows the debtor to settle her debt. The fear to lose the collateral creates future money demand by the debtor and thereby ensures positive money value. (2) Money is a safe asset as not only a single but all debtors in the economy demand money so that idiosyncratic shocks to solvency wash out. By this mechanism, fiat money is essentially equivalent to large securitized pools of debt which (3) can establish the pooling allocation even if pooling itself is infeasible.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0165176512000560
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    Bibliographic Info

    Article provided by Elsevier in its journal Economics Letters.

    Volume (Year): 116 (2012)
    Issue (Month): 2 ()
    Pages: 193-198

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    Handle: RePEc:eee:ecolet:v:116:y:2012:i:2:p:193-198

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    Web page: http://www.elsevier.com/locate/ecolet

    Related research

    Keywords: Fiat money; Securitization; Safe asset; Collateral;

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    1. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
    2. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
    3. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
    4. Grandmont, Jean-Michel & Younes, Yves, 1972. "On the Role of Money and the Existence of a Monetary Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 39(3), pages 355-72, July.
    5. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March.
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