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Fiat Money and Public Goods Provision


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  • Akihiko Matsui
  • Yiting Li


This paper studies how government uses inflation tax to finance public goods affects the circulation of a national currency in a two-country search theoretic model. Each country consists of infinitely-lived private agents and a government. A representative agent obtains utility from the private good and the public good of his own country. Each government prints fiat money to purchase goods, taxes on money holdings, and provides public goods by purchasing private goods from its fellow citizens. While government purchases increase the demand for the private goods, it also induces a crowding-out effect by reducing the matching rates among private agents. Agents interact with home and foreign agents in different frequencies, reflecting the relative country size and the degree of international economic integration. We conduct some comparative statics. For example, a higher inflation tax rate makes a currency less likely to circulate locally and internationally. We then consider a policy game in which the two governments choose tax rates on their respective currencies, measuring the payoff of each government by the utility of its own representative agent. It is shown, among others, that the equilibrium tax rate of a currency is higher when it becomes an international currency than otherwise. Welfare may be improved for the issuing country of the international currency when its currency supply is not too low, for that circulation of a currency abroad may create currency shortage at home

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 634.

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Date of creation: 2004
Date of revision:
Handle: RePEc:red:sed004:634

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Keywords: Fiat money; Public goods; Inflation tax; International currency;

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Cited by:
  1. Hans Pitlik & Margit Schratzenstaller, 2011. "Growth Implications of Structure and Size of Public Sectors," WIFO Working Papers 404, WIFO.


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