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Toward a Theory of International Currency

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  • Kiminori Matsuyama

Abstract

Our goal is to provide a theoretical framework in which both positive and negative aspects of international currency can be addressed in a systematic way. To this end, we use the framework of random matching games and develop a two country model of the world economy, in which two national fiat currencies compete and may be circulated as media of exchange. There are multiple equilibrium which differ in the areas of circulation of the two currencies. In one equilibrium, the two national currencies are circulated only locally. In another, one of the national currencies is circulated as an international currency. There is also an equilibrium in which both currencies are accepted internationally. We also find an equilibrium in which the two currencies are directly exchanged. The existence conditions of these equilibria are characterized, using the relative country size and the degree of economic integration as the key parameters. In order to generate sharper predictions in he presence of multiple equilibria, we discuss an evolutionary approach to equilibrium selection, which is used to explain the evolution of the international currency as the two economies become more integrated. Some welfare implications are also discussed. For example, a country can improve its national welfare by letting its own currency circulated internationally, provided the domestic circulation is controlled for. When the total supply is fixed, however, a resulting currency shortage may reduce the national welfare.

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Bibliographic Info

Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 931.

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Date of creation: Mar 1991
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Handle: RePEc:nwu:cmsems:931

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Keywords: Best Response Dynamics; Evolution of International Currency; Money as a Medium of Exchange; Multiple Currencies; (Nonuniform) Random Matching Games;

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  1. Kiyotaki, N. & Wright, R., 1990. "Search For A Theory Of Money," Working papers 90-15, Wisconsin Madison - Social Systems.
  2. Kandori, M. & Mailath, G.J., 1991. "Learning, Mutation, And Long Run Equilibria In Games," Papers 71, Princeton, Woodrow Wilson School - John M. Olin Program.
  3. Lopez, Robert Sabatino, 1951. "The Dollar of the Middle Ages," The Journal of Economic History, Cambridge University Press, vol. 11(03), pages 209-234, June.
  4. Jones, Robert A, 1976. "The Origin and Development of Media of Exchange," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(4), pages 757-75, August.
  5. Matsui, Akihiko, 1992. "Best response dynamics and socially stable strategies," Journal of Economic Theory, Elsevier, vol. 57(2), pages 343-362, August.
  6. 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.
  7. Jovanovic, Boyan & Rosenthal, Robert W., 1988. "Anonymous sequential games," Journal of Mathematical Economics, Elsevier, vol. 17(1), pages 77-87, February.
  8. Nobuhiro Kiyotaki & Randall Wright, 1989. "A contribution to the pure theory of money," Staff Report, Federal Reserve Bank of Minneapolis 123, Federal Reserve Bank of Minneapolis.
  9. I. Gilboa & A. Matsui, 2010. "Social Stability and Equilibrium," Levine's Working Paper Archive 534, David K. Levine.
  10. Lucas, Robert E, Jr, 1986. "Adaptive Behavior and Economic Theory," The Journal of Business, University of Chicago Press, vol. 59(4), pages S401-26, October.
  11. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(4), pages 927-54, August.
  12. Paul R. Krugman, 1984. "The International Role of the Dollar: Theory and Prospect," NBER Chapters, in: Exchange Rate Theory and Practice, pages 261-278 National Bureau of Economic Research, Inc.
  13. John F. O. Bilson & Richard C. Marston, 1984. "Exchange Rate Theory and Practice," NBER Books, National Bureau of Economic Research, Inc, number bils84-1, Ekim.
  14. Krugman, Paul, 1980. "Vehicle Currencies and the Structure of International Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 12(3), pages 513-26, August.
  15. Marimon, Ramon & McGrattan, Ellen & Sargent, Thomas J., 1990. "Money as a medium of exchange in an economy with artificially intelligent agents," Journal of Economic Dynamics and Control, Elsevier, vol. 14(2), pages 329-373, May.
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