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Imperfect Monitoring And The Discounting Of Inside Money

  • David C. Mills, Jr

This article evaluates the efficiency of a requirement that private issuers redeem inside money on demand at par in a random-matching model of money where the issuers of inside money are imperfectly monitored. I find that for sufficiently imperfect monitoring, a par redemption requirement leads to lower social welfare than if private money were redeemed at a discount. A central message of the article is that if inside money and outside money are not perfect substitutes, a par redemption requirement may not be socially optimal because such a requirement effectively binds them to circulate as if they are. Copyright � 2008 the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 49 (2008)
Issue (Month): 3 (08)
Pages: 737-754

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Handle: RePEc:ier:iecrev:v:49:y:2008:i:3:p:737-754
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  1. Arthur J. Rolnick & Warren E. Weber, 1988. "Explaining the demand for free bank notes," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 21-35.
  2. David C. Mills, Jr., 2006. "A model in which outside and inside money are essential," Finance and Economics Discussion Series 2006-38, Board of Governors of the Federal Reserve System (U.S.).
  3. Klein, Benjamin, 1974. "The Competitive Supply of Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(4), pages 423-53, November.
  4. Stephen D. Williamson, 1999. "Private money," Proceedings, Federal Reserve Bank of Cleveland, pages 469-499.
  5. James Bullard & Bruce D. Smith, 2001. "The value of inside and outside money," Working Papers 2000-027, Federal Reserve Bank of St. Louis.
  6. Azariadis, Costas & Bullard, James & Smith, Bruce D., 2001. "Private and Public Circulating Liabilities," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 59-116, July.
  7. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
  8. King, Robert G., 1983. "On the economics of private money," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 127-158.
  9. 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.
  10. S. Rao Aiyagari & Neil Wallace & Randall Wright, 1996. "Coexistence of money and interest-bearing securities," Working Papers 550, Federal Reserve Bank of Minneapolis.
  11. Arthur J. Rolnick & Bruce D. Smith & Warren E. Weber, 1998. "Lessons from a laissez-faire payments system: the Suffolk Banking System (1825-58)," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 11-21.
  12. Juan Pablo Nicolini & Ramon Marimon & Pedro Teles, 2001. "Inside Outside Money Competition," Department of Economics Working Papers 004, Universidad Torcuato Di Tella.
  13. Rolnick, Arthur J. & Weber, Warren E., 1988. "Explaining the demand for free bank notes," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 47-71, January.
  14. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
  15. 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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