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Currency competition : a partial vindication of Hayek

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  • Antoine Martin
  • Stacey L. Schreft

Abstract

This paper establishes the existence of equilibria for environments in which outside money is issued competitively. Such equilibria are typically believed not to exist because of a classic overissue problem: if money is valued in equilibrium, an issuer produces money until its value is driven to zero. By backward induction, money cannot have value in the first place. However, for any given finite amount of money outstanding, a monetary economy typically has two equilibria. In one, money has value; in the other, money is not valued because no one expects it to be valued. This paper takes this latter equilibrium seriously and shows that trigger strategies eliminate the overissue problem if agents have beliefs of the following type: if an issuer produces money beyond some threshold amount, then the issuer’s money has no value. This result is very general, applying to any monetary economy in which equilibria with and without valued money exist if the money supply is finite. The paper also compares the allocation achieved by a monopolist to that achieved with competitive issuance in both a search and an overlapping-generations environment. The results depend on the environment considered, but two general conclusions arise. First, it is ambiguous whether competitive issuers can achieve a more desirable allocation than a monopolist. Second, with competitive issuance, a licensing agency can always improve on pure laissez-faire and achieve the efficient allocation in the long run.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 03-04.

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Date of creation: 2003
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Handle: RePEc:fip:fedkrw:rwp03-04

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Keywords: Equilibrium (Economics) ; Money;

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References

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  1. Gabriele Camera & Ben Craig & Christopher J. Waller, 2003. "Currency competition in a fundamental model of money," Working Paper 0311, Federal Reserve Bank of Cleveland.
  2. Cavalcanti, Ricardo de O & Wallace, Neil, 1999. "Inside and Outside Money as Alternative Media of Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 443-57, August.
  3. Ricardo de O. Cavalcanti & Andres Erosa & Ted Temzelides, 1999. "Private Money and Reserve Management in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 929-945, October.
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  7. Wright Randall, 1994. "A Note on Sunspot Equilibria in Search Models of Fiat Money," Journal of Economic Theory, Elsevier, vol. 64(1), pages 234-241, October.
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  14. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
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  16. Aleksander Berentsen, . "Time-Consistent Private Supplie of Outside Paper Money," IEW - Working Papers 156, Institute for Empirical Research in Economics - University of Zurich.
  17. Nobuhiro Kiyotaki & Randall Wright, 1989. "A contribution to the pure theory of money," Staff Report 123, Federal Reserve Bank of Minneapolis.
  18. Burdett, Kenneth & Trejos, Alberto & Wright, Randall, 2001. "Cigarette Money," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 117-142, July.
  19. 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.
  20. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  21. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "A model of private bank-note issue," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 104-136, January.
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  24. Peterson Brian, 2009. "Endogenous Liquidity and Currency Unions," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-34, March.
  25. Monnet, Cyril, 2002. "Optimal public money," Working Paper Series 0159, European Central Bank.
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Citations

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Cited by:
  1. Berentsen, Aleksander, 2006. "On the private provision of fiat currency," European Economic Review, Elsevier, vol. 50(7), pages 1683-1698, October.
  2. Daniel Sanches, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia, revised 04 Feb 2013.
  3. Li, Yiting & Matsui, Akihiko, 2009. "A theory of international currency: Competition and discipline," Journal of the Japanese and International Economies, Elsevier, vol. 23(4), pages 407-426, December.
  4. Daniel R. Sanches, 2012. "On the inherent instability of private money," Working Papers 12-19, Federal Reserve Bank of Philadelphia.
  5. Daniel R. Sanches, 2013. "Banking crises and the role of bank coalitions," Working Papers 13-28, Federal Reserve Bank of Philadelphia, revised 04 Feb 2014.
  6. Li, Yan, 2009. "The theory of fiat money and private money as alternative media of exchange," International Review of Economics & Finance, Elsevier, vol. 18(4), pages 568-582, October.
  7. Holthausen, Cornelia & Monnet, Cyril, 2003. "Money and payments: a modern perspective," Working Paper Series 0245, European Central Bank.

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