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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. S. Rao Aiyagari & Neil Wallace, 1995. "Government transaction policy, the medium of exchange, and welfare," Working Papers 516, Federal Reserve Bank of Minneapolis.
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  19. Gabriele Camera & Ben Craig & Christopher J. Waller, 2003. "Currency competition in a fundamental model of money," Working Paper 0311, Federal Reserve Bank of Cleveland.
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Citations

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Cited by:
  1. Daniel R. Sanches, 2012. "On the inherent instability of private money," Working Papers 12-19, Federal Reserve Bank of Philadelphia.
  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. Berentsen, Aleksander, 2006. "On the private provision of fiat currency," European Economic Review, Elsevier, vol. 50(7), pages 1683-1698, October.
  4. Holthausen, Cornelia & Monnet, Cyril, 2003. "Money and payments: a modern perspective," Working Paper Series 0245, European Central Bank.
  5. Iwamura, Mitsuru & Kitamura, Yukinobu & Matsumoto, Tsutomu, 2014. "Is Bitcoin the Only Cryptocurrency in the Town? Economics of Cryptocurrency and Friedrich A.Hayek," Discussion Paper Series 602, Institute of Economic Research, Hitotsubashi University.
  6. 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.
  7. 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.
  8. 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.

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