Currency competition: a partial vindication of Hayek Martin, Antoine; Schreft, Stacey L

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Martin, Antoine ; Schreft, Stacey L
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Journal of Monetary Economics
Money - Mathematical models.; Federal reserve banks; Banking industry
Academic; Trade
To link to full-text access for this article, visit this link: Byline: Antoine Martin, Stacey L. Schreft Keywords: Currency competition; Hayek; Outside money; Private money; Fiat money Abstract: This paper establishes the existence of equilibria for environments in which outside money is issued competitively. Such equilibria are typically believed not to exist because of a classic overissue problem: if money is valued in equilibrium, an issuer produces money until its value is driven to zero. By backward induction, money cannot have value in the first place. This paper shows that overissuance is not a problem if agents believe that if an issuer produces more than some threshold number of notes, then only those notes issued up to the threshold will be valued; additional notes will be worthless. This result is very general, applying to any monetary economy in which equilibria with and without valued money exist if the money supply is finite. The paper also compares the allocation achieved by a monopolist to that achieved with competitive issuance in both a search and an overlapping-generations environment. The results depend on the environment considered, but two general conclusions arise. First, it is ambiguous whether competitive issuers can achieve a more desirable allocation than a monopolist. Second, with competitive issuance, a licensing agency can always improve on pure laissez-faire and achieve the efficient allocation in the long run. Author Affiliation: Research Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045, USA Economic Research Department, Federal Reserve Bank of Kansas City, 925 Grand Building, Kansas City, MO 64198, USA Article History: Received 27 October 2004; Revised 5 April 2005; Accepted 11 April 2005 Article Note: (footnote) [star] The authors thank Warren Weber, Randy Wright, and participants in the Federal Reserve Bank of Cleveland's 2003 Banking and Payments Workshop, the 2004 SED Conference in Paris, and various university seminars for helpful comments. They also thank Aarti Singh for valuable research assistance. The views expressed are the authors' and do not necessarily reflect those of the Federal Reserve Bank of New York, Federal Reserve Bank of Kansas City, or the Federal Reserve System.
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