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Inside and outside fiat money, gains to trade, and IS-LM

Author

Listed:
  • Pradeep Dubey
  • John Geanakoplos

Abstract

We build a one-period general equilibrium model with money. Equilibrium exists, and fiat money has positive value, as long as the ratio of outside money to inside money is less than the gains to trade available at autarky. We show that the nominal effects of government fiscal and monetary policy can be completely described by a diagram identical in form to the IS-LM curves introduced by Hicks to describe Keynes' general theory. IS-LM analysis is thus not incompatible with full market clearing, multiple commodities, and heterogeneous households. We show that as the government deficit approaches a finite threshold, hyperinflation sets in (prices converge to infinity and real trade collapses). At the other extreme, if the government surplus is too large, the economy enters a liquidity trap in which nominal GNP sinks and monetary policy is ineffectual. Copyright Springer-Verlag Berlin Heidelberg 2003

Suggested Citation

  • Pradeep Dubey & John Geanakoplos, 2003. "Inside and outside fiat money, gains to trade, and IS-LM," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(2), pages 347-397, March.
  • Handle: RePEc:spr:joecth:v:21:y:2003:i:2:p:347-397
    DOI: 10.1007/s00199-002-0296-5
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    Keywords

    Keywords and Phrases: Central bank; Gains to trade; Inside money; IS-LM; Outside money.; JEL Classification Numbers: D50; E40; E50; E58.;
    All these keywords.

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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