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Limited Commitment and the Legal Restrictions Theory of the Demand for Money

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Abstract

This paper addresses the "rate of return" puzzle of monetary theory. Similarly to the legal restrictions theory of the demand for money, we assume that Government bonds are subject to a minimum purchase requirement. Differently from this theory, however, we assume that intermediaries, when issuing private notes, cannot commit to always redeem them. First, we study an environment with legal restrictions to intermediation and show that cash and interest bearing bonds both circulate in the economy. Then, we drop the legal restrictions and show that also with active intermediation, under limited commitment, there is an equilibrium with rate of return dominance. A positive interest rate provides the intermediaries with the incentive to issue and redeem their notes.

Suggested Citation

  • Leo Ferraris & Fabrizio Mattesini, 2013. "Limited Commitment and the Legal Restrictions Theory of the Demand for Money," CEIS Research Paper 262, Tor Vergata University, CEIS, revised 21 Jan 2013.
    • Handle: RePEc:rtv:ceisrp:262
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    Cited by:

    1. Rojas Breu, Mariana, 2017. "Debt enforcement and the value of money," Journal of Economic Theory, Elsevier, vol. 168(C), pages 237-251.
    2. Park, Jaevin & Kwon, Ohik, 2023. "Stablecoins: Legal restrictions theory and monetary policy," Economics Letters, Elsevier, vol. 226(C).
    3. Luis Araujo & Leo Ferraris, 2020. "Money, Bonds, and the Liquidity Trap," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(7), pages 1853-1867, October.
    4. Luis Araujo & Leo Ferraris, 2019. "The Societal Benefits of Money and Interest Bearing Debt," CEIS Research Paper 453, Tor Vergata University, CEIS, revised 19 Feb 2019.

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    Keywords

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    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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