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Strong Currency and Weak Currency

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  • Matsui, Akihiko

Abstract

This paper presents a two-country model in which two currencies compete with each other. There exists an equilibrium in which the two currencies with different rates of inflation circulate as media of exchange despite that neither currency is forced to be used for transactions. Taxes payable in local currency and asymmetric injection of fiat money by government through purchases of a certain good generate demands even for the currency with a higher inflation rate. In such an equilibrium, the government that issues the currency with a lower rate of inflation collects seigniorage not only from its own residents but from the residents of the other country provided that the rate of inflation is positive. The strong currency in the sense of a low inflation rate becomes an international medium of exchange. Policy games, in which two governments simultaneously choose and commit to tax rates and inflation rates, are also examined. We show, among other things, that the equilibrium rate of inflation is zero in this policy game. In other words, unlike a common argument, the rate of inflation does not go below zero. This result is due to the fact that a negative rate of inflation induces a negative amount of seigniorage and vice versa. Some alternative currency regimes are examined. Even for a country with a weak currency, abandonment of its currency leads to a lower level of welfare. Monetary unions are briefly discussed as well.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of the Japanese and International Economies.

Volume (Year): 12 (1998)
Issue (Month): 4 (December)
Pages: 305-333

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Handle: RePEc:eee:jjieco:v:12:y:1998:i:4:p:305-333

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Web page: http://www.elsevier.com/locate/inca/622903

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References

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  1. Hayashi, Fumio & Matsui, Akihiko, 1996. "A Model of Fiat Money and Barter," Journal of Economic Theory, Elsevier, vol. 68(1), pages 111-132, January.
  2. King, Robert G. & Wallace, Neil & Weber, Warren E., 1992. "Nonfundamental uncertainty and exchange rates," Journal of International Economics, Elsevier, vol. 32(1-2), pages 83-108, February.
  3. Oh, Seonghwan, 1989. "A theory of a generally acceptable medium of exchange and barter," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 101-119, January.
  4. Engineer, Merwan & Bernhardt, Dan, 1991. "Money, Barter, and the Optimality of Legal Restrictions," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 743-73, August.
  5. 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.
  6. Shapley, Lloyd S. & Shubik, Martin, 1969. "On market games," Journal of Economic Theory, Elsevier, vol. 1(1), pages 9-25, June.
  7. Zhou, Ruilin, 1997. "Currency Exchange in a Random Search Model," Review of Economic Studies, Wiley Blackwell, vol. 64(2), pages 289-310, April.
  8. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
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Cited by:
  1. Helmut Frisch, 2003. "The euro and its consequences: What makes a currency strong?," Atlantic Economic Journal, International Atlantic Economic Society, vol. 31(1), pages 15-31, March.
  2. Munetomo Ando & Daisuke Oyama, 2002. "A model of a spatial economy with trading posts," Economics Bulletin, AccessEcon, vol. 18(1), pages 1-11.
  3. repec:ebl:ecbull:v:18:y:2002:i:1:p:1-11 is not listed on IDEAS
  4. Martin, Antoine, 2006. "Endogenous Multiple Currencies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 245-262, February.

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