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Limited Commitment and the Legal Restrictions Theory of the Demand for Money

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This paper addresses the "rate of return" puzzle of monetary theory. Similarly to the legal restrictions theory of the demand for money, we assume that Government bonds are subject to a minimum purchase requirement. Differently from this theory, however, we assume that intermediaries, when issuing private notes, cannot commit to always redeem them. First, we study an environment with legal restrictions to intermediation and show that cash and interest bearing bonds both circulate in the economy. Then, we drop the legal restrictions and show that also with active intermediation, under limited commitment, there is an equilibrium with rate of return dominance. A positive interest rate provides the intermediaries with the incentive to issue and redeem their notes.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 262.

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Length: 33 pages
Date of creation: 21 Jan 2013
Date of revision: 21 Jan 2013
Handle: RePEc:rtv:ceisrp:262

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Web: http://www.ceistorvergata.it

Related research

Keywords: Money; Government Bonds; Rate of Return Dominance; Legal Restrictions;

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