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A Theory of International Currency and Seigniorage Competition

Author

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  • Yiting Li

    (Department of Economics, National Twaiwan University)

  • Akihiko Matsui

    (Faculty of Economics, University of Tokyo)

Abstract

This paper explicitly considers strategic interaction between governments to study currency competition and its effects on the circulation of currencies and welfare in a two-country, two-currency search theoretic model. Each government uses seigniorage to provide public goods. Agents consume private goods, and the public goods of their own country. We have several findings. The negative impact of a country's inflationary policy on the realm of circulation of its currency imposes an inflation discipline: the more open a country is, the stronger is the discipline. The worldwide circulation of a currency increases seigniorage and welfare and decreases the inflation rate of the issuing country compared to autarky. The other country, since the tax base is reduced due to the use of foreign currency, raises its inflation rate. However, there is a limit on the rate beyond which it cannot maintain the circulation of national money. Under strategic interaction between governments in selecting equilibrium, the larger country would try to lower the inflation rate to make its currency circulate abroad, while the other country may also lower the inflation rate to sustain its national currency as the sole medium of exchange.

Suggested Citation

  • Yiting Li & Akihiko Matsui, 2005. "A Theory of International Currency and Seigniorage Competition," CARF F-Series CARF-F-041, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  • Handle: RePEc:cfi:fseres:cf041
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    File URL: http://www.carf.e.u-tokyo.ac.jp/pdf/workingpaper/fseries/42.pdf
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    References listed on IDEAS

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    1. Canzoneri, Matthew B., 1989. "Adverse incentives in the taxation of foreigners," Journal of International Economics, Elsevier, vol. 27(3-4), pages 283-297, November.
    2. Christopher J. Waller & Elisabeth S. Curtis, 2003. "Currency restrictions, government transaction policies and currency exchange," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(1), pages 19-42, January.
    3. Head, Allen & Shi, Shouyong, 2003. "A fundamental theory of exchange rates and direct currency trades," Journal of Monetary Economics, Elsevier, pages 1555-1591.
    4. Motomura, Akira, 1994. "The Best and Worst of Currencies: Seigniorage and Currency Policy in Spain, 1597–1650," The Journal of Economic History, Cambridge University Press, vol. 54(01), pages 104-127, March.
    5. Ruilin Zhou, 1997. "Currency Exchange in a Random Search Model," Review of Economic Studies, Oxford University Press, vol. 64(2), pages 289-310.
    6. Fischer, Stanley, 1982. "Seigniorage and the Case for a National Money," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 295-313, April.
    7. Green, Edward J. & Zhou, Ruilin, 1998. "A Rudimentary Random-Matching Model with Divisible Money and Prices," Journal of Economic Theory, Elsevier, vol. 81(2), pages 252-271, August.
    8. Kazuya Kamiya & Takashi Sato, 2004. "Equilibrium Price Dispersion in a Matching Model with Divisible Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 413-430, May.
    9. Li, Victor E, 1995. "The Optimal Taxation of Fiat Money in Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 927-942, November.
    10. Russell Cooper & Hubert Kempf, 2003. "Commitment and the Adoption of a Common Currency," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 119-142, February.
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    Cited by:

    1. Marc Flandreau & Clemens Jobst, 2006. "The Empirics of International Currencies: Evidence from the 19th Century," Working Papers hal-01065631, HAL.
    2. repec:spo:wpecon:info:hdl:2441/669 is not listed on IDEAS

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