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A model in which outside and inside money are essential

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  • David C. Mills

Abstract

I present an environment for which both outside and inside money are essential as means of payment. The key model feature is that there is imperfect monitoring of issuers of inside money. I use a random matching model of money where some agents have private trading histories and others have trading histories that can be publicly observed only after a lag. I show via an example that for lags that are neither too long nor too short, there exist allocations that use both types of money that cannot be duplicated when only one type is used. Inside money provides liquidity that increases the frequency of trades, but incentive constraints restrict the amount of output that can be traded. Outside money is immune to such constraints and can trade for higher levels of output.

Suggested Citation

  • David C. Mills, 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.).
  • Handle: RePEc:fip:fedgfe:2006-38
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    References listed on IDEAS

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    Cited by:

    1. Cavalcanti, Ricardo de Oliveira & Forno, Henrique Dezemone, 2004. "Money with Bank Networks," FGV/EPGE Economics Working Papers (Ensaios Economicos da EPGE) 545, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
    2. David C. Mills, Jr, 2008. "Imperfect Monitoring And The Discounting Of Inside Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(3), pages 737-754, August.
    3. Pedro Gomis‐Porqueras & Daniel Sanches, 2013. "Optimal Monetary Policy in a Model of Money and Credit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 701-730, June.
    4. Neil Wallace, 2000. "Knowledge of individual histories and optimal payment arrangements," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 11-21.
    5. Ricardo de O. Cavalcanti & Andrés Erosa & Ted Temzelides, 2005. "Liquidity, Money Creation And Destruction, And The Returns To Banking," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 675-706, May.
    6. Daniel Sanches, 2016. "On the Inherent Instability of Private Money," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 198-214, April.
    7. Chao Gu & Fabrizio Mattesini & Randall Wright, 2016. "Money and Credit Redux," Econometrica, Econometric Society, vol. 84, pages 1-32, January.
    8. Mei Dong, 2009. "Money and Costly Credit," 2009 Meeting Papers 404, Society for Economic Dynamics.
    9. Daniel R. Sanches, 2013. "Banking crises and the role of bank coalitions," Working Papers 13-28, Federal Reserve Bank of Philadelphia, revised 04 Feb 2014.
    10. Sissoko, Carolyn, 2007. "An Idealized View of Financial Intermediation," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 1, pages 1-29.
    11. Madeira, Gabriel A. & Townsend, Robert M., 2008. "Endogenous groups and dynamic selection in mechanism design," Journal of Economic Theory, Elsevier, vol. 142(1), pages 259-293, September.
    12. Sanches, Daniel, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia, revised 04 Feb 2013.
    13. Daniel Sanches, 2016. "On The Welfare Properties Of Fractional Reserve Banking," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 935-954, August.
    14. Chao Gu & Fabrizio Mattesini & Randall Wright, 2015. "Money and Credit Redux," Working Papers 1508, Department of Economics, University of Missouri.
    15. Araujo, Luis & Camargo, Braz, 2015. "Limited monitoring and the essentiality of money," Journal of Mathematical Economics, Elsevier, vol. 58(C), pages 32-37.

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    Keywords

    Money theory ; Econometric models ; Payment systems;

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