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A model in which outside and inside money are essential

  • David C. Mills, Jr.

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.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2006-38.

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Date of creation: 2006
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Handle: RePEc:fip:fedgfe:2006-38
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  1. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  2. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  3. S. Rao Aiyagari & Neil Wallace & Randall Wright, 1996. "Coexistence of money and interest-bearing securities," Working Papers 550, Federal Reserve Bank of Minneapolis.
  4. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  5. Joseph M. Ostroy, 1972. "The Informational Efficiency of Monetary Exchange," UCLA Economics Working Papers 021, UCLA Department of Economics.
  6. Kocherlakota, Narayana & Wallace, Neil, 1998. "Incomplete Record-Keeping and Optimal Payment Arrangements," Journal of Economic Theory, Elsevier, vol. 81(2), pages 272-289, August.
  7. Townsend, Robert M, 1989. "Currency and Credit in a Private Information Economy," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1323-44, December.
  8. 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.
  9. 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.
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