Money and storage in a differential information economy

Summary Is the use of fiat money essential in any efficient organization of exchange? We investigate this question in economies that are generalizations of the Townsend (1980) turnpike model that include limited commitment and differential information. We show that in the Townsend turnpike model fiat money is not essential unless there is limited commitment. Furthermore, fiat money has no role whenever there is storage with positive returns. In the presence of differential information fiat money is essential in overcoming incentive problems. This is the case even if there is storage with positive returns.We wish to thank Bart Taub, Anne Villamil and seminar participants at the University of Chicago, the Federal Reserve Bank of Minneapolis, Ohio State, the 1994 North American Summer Meeting of the Econometric Society, SEDC 1994, and Oberwolfach 1994.     

On the optimality of interest-bearing reserves in economies of overlapping generations

Summary Paying interest on required reserves is considered in an overlapping generations model in which the return to capital dominates the return to fiat money. As Smith (1991) showed, financing interest on reserves benefits the initial old at the expense of future generations. We show that the transfer of wealth associated with interest on reserves can be offset by an accommodating open market purchase, so that the payment of interest on reserves is a Pareto improvement. We also show that paying interest on reserves improves welfare even when financed by distorting taxes on capital.The authors thank Mike Cox, Greg Huffman, Evan Koenig, and Bruce Smith for helpful discussion. Any remaining errors are solely ours. This work originated while Freeman was a Research Associate at the Federal Reserve Bank of Dallas. The views expressed herein do not necessarily reflect those of the Federal Reserve Bank of Dallas or the Federal Reserve System.     

Transaction costs and the use of cash and credit

Summary An overlapping generations model with spatial separation and transaction costs is developed that displays steady state equilibria in which both cash (fiat currency) and trade credit are used in exchange. Equilibria in which trade credit is used are not Pareto optimal. The question of the optimal quantity of money is addressed. Deflation is found to be optimal, contrary to the result for standard overlapping generations environments.This paper is based upon my dissertation, written for the University of Minnesota. I am grateful to Kathryn Combs, Michael Dotsey, Bruce Horning, Anne Villamil and seminar participants at numerous institutions for helpful comments. Most of all, I want to thank my advisor, Neil Wallace, for the attention he gave to my work. The views expressed in this paper are solely those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Richmond or the Federal Reserve System.     

A note concerning a credit rule for monetary policy

A technique introduced by Friedman is used to analyze the ability of the Federal Reserve to control the money supply. We find that the necessary conditions for control are so restrictive that a constant growth rate for the money stock may not be achievable. We suggest, therefore, a steady growth rate for Federal Reserve Credit.     

Money and capital as competing media of exchange

We construct a model where capital competes with fiat money as a medium of exchange, and establish conditions on fundamentals under which fiat money can be both valued and socially beneficial. When the socially efficient stock of capital is too low to provide the liquidity agents need, they overaccumulate productive assets to use as media of exchange. When this is the case, there exists a monetary equilibrium that dominates the nonmonetary one in terms of welfare. Under the Friedman Rule, fiat money provides just enough liquidity so that agents choose to accumulate the same capital stock a social planner would.     

Limited participation,private money,and credit in a spatial model of money

Summary. The purpose of this paper is to explore the implications of private money issue for the effects of monetary policy, for optimal policy, and for the role of fiat money. A locational model is constructed which gives an explicit account of the role for money and credit, and for limited financial market participation. When private money issue is prohibited, there is a liquidity effect as the result of a money injection from the central bank, but this effect goes away when private money is permitted. Private money issue changes dramatically the nature of optimal monetary policy. With private money, fiat currency is no longer used in transactions involving goods, but currency and central bank reserves play an important part in the clearing and settlement of private money returned for redemption.Received: 5 May 2003, Revised: 1 December 2003JEL Classification Numbers: E4, E5.The author thanks seminar participants at the Federal Reserve Bank of Richmond and Duke University, conference participants at the Texas Monetary Conference at U.T. Austin, February 2002, and the Conference on Recent Developments in Money and Finance at Purdue University, May 2003, as well as Gabriele Camera, Ed Nosal, Will Roberds, and two anonymous referees for their helpful comments and suggestions.     

More on money as a medium of exchange

Summary We extend the analysis of Kiyotaki and Wright, who study economies where the commodities that serve as media of exchange (or, commodity money) are determined endogenously. Kiyotaki and Wright consider only steady-state, pure-strategy equilibria; here we allow dynamic and mixed-strategy equilibria. We demonstrate that symmetric, steady-state equilibria in mixed-strategies always exist, while sometimes no such equilibria exist in pure-strategies. We prove that the number of symmetric steady-state equilibria is generically finite. We also show, however, that for some parameter values there exists a continuum of dynamic equilibria. Further, some equilibria display cycles.We thank the National Science Foundation and the University of Pennsylvania Research Foundation for financial support, as well as seminar participants at Stanford University, the London School of Economics, the Econometric Society World Congress in Barcelona, and the Conference on Monetary Theory and Financial Institutions at the Federal Reserve Bank of Minneapolis for their comments or suggestions. Alberto Trejos provided research assistance. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.     

Why is there money? Endogenous derivation of `money' as the most liquid asset: a class of examples

Summary. The monetary character of trade, use of a common medium of exchange, is shown to be an outcome of an economic general equilibrium. Monetary structure can be derived from price theory in a modified Arrow-Debreu model. Two constructs are added: transaction costs and market segmentation in trading posts (with a separate budget constraint at each transaction). Commodity money arises endogenously as the most liquid (lowest transaction cost) asset. Government-issued fiat money has a positive equilibrium value from its acceptability for tax payments. Scale economies in transaction cost account for uniqueness of the (fiat or commodity) money in equilibrium. Received: February 15, 2002; revised version: August 12, 2002 RID="*" ID="*" This paper has benefited from seminars and colleagues' helpful remarks at the University of California - Santa Barbara, University of California - San Diego, NSF-NBER Conference on General Equilibrium Theory at Purdue University, Society for the Advancement of Behavioral Economics at San Diego State University, Econometric Society at the University of Wisconsin - Madison, SITE at Stanford University-2001, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Minneapolis, Midwest Economic Theory Conference at the University of Illinois - Urbana Champaign, University of Iowa, Southern California Economic Theory Conference at UC - Santa Barbara, Midwest Macroeconomics Conference at University of Iowa, University of California - Berkeley, European Workshop on General Equilibrium Theory at University of Paris I, Society for Economic Dynamics at San Jose Costa Rica, World Congress of the Econometric Society at University of Washington, Cowles Foundation at Yale University. It is a pleasure to acknowledge comments of Henning Bohn, Harold Cole, James Hamilton, Mukul Majumdar, Harry Markowitz, Chris Phelan, Meenakshi Rajeev, Wendy Shaffer, Bruce Smith, and Max Stinchcombe.     

A monetary mechanism for sharing capital: Diamond and Dybvig meet Kiyotaki and Wright

Summary. A model is presented in which banks update public records, accept deposits of fiat money and intermediate capital. I show that inside money is more liquid than outside money, increasing the turnover rates of idle capital. The model offers a simple explanation for the dual role of financial institutions: Banks are monitored and can issue nominal assets upon request, which helps them to transfer capital in sufficiently high rates and to also become intermediaries. The model shares some features with those of Diamond and Dybvig [5], and Kiyotaki and Wright [7].Received: 18 February 2003, Revised: 16 February 2004, JEL Classification Numbers: E51, G21, G24.Ricardo de O. Cavalcanti: I thank two anonymous referees, Susumu Imai, B. Ravikumar and Neil Wallace, as well as participants at the Economic Theory symposium Recents Developments in Money and Finance, and seminar participants at the Richmond Fed, Queens University, and Sabanci University for comments on an early draft. The hospitality and financial support of the Cleveland Fed Central Bank Institute and CNPq are greatfully appreciated. The authors opinions are not necessarily those of the Federal Reserve Bank of Cleveland or the Federal Reserve System.     

An experimental examination of the house money effect in a multi-period setting

There is evidence that risk-taking behavior is influenced by prior monetary gains and losses. When endowed with house money, people become more risk taking. This paper is the first to report a house money effect in a dynamic, financial setting. Using an experimental method, we compare market outcomes across sessions that differ in the level of cash endowment (low and high). Our experimental results provide support for a house money effect. Traders’ bids, price predictions, and market prices are influenced by the amount of money that is provided prior to trading. However, dynamic behavior is difficult to interpret due to conflicting influences. JEL Classification C91 · C92 · D80 The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.     

A monetary economy with counterfeiting

We apply a search-theoretic model of fiat money to study the equilibria in which counterfeit money is accepted. Circulation of counterfeit money presupposes that the agents are impatient and that the punishment for holding it is not too severe. When the stock of genuine money is small counterfeit money may improve the efficiency of the economy. We establish that a monetary economy can be created with private provision of (counterfeit) money as long as the ruler has control over punishments. Totally noncooperative provision will fail as the economy will become flooded with money.     

Empirical modeling of money demand

This paper examines several central issues in the empirical modeling of money demand. These issues include economic theory, data measurement, parameter constancy, the opportunity cost of holding money, cointegration, model specification, exogeneity, and inferences for policy. Review of these issues at a general level is paralleled by discussion of specific empirical applications, including some new results on the demand for narrow money in the United Kingdom.The author is a staff economist in the Division of International Finance, Board of Governors of the Federal Reserve System, Washington, DC 20551 USA, and may be reached on the Internet at ericsson@frb.gov. The views in this paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System, the Reserve Bank of Australia, or any other person associated with the Federal Reserve System or the Reserve Bank of Australia. I am grateful for the generous hospitality of the Reserve Bank of Australia, where I was on secondment when this research was begun. I also wish to thank Tony Brennan, Gordon de Brouwer, Julia Campos, Ed Nelson, Jerome Fahrer, Jon Faust, Steve Grenville, David Hendry, John Irons, Katarina Juselius, Neva Kerbeshian, Helmut Lütkepohl, Dieter Nautz, Athanasios Orphanides, Kevin Prestwich, Robert Subbaraman, Timo Teräsvirta, Jenny Wilkinson, Jürgen Wolters, and two anonymous referees for helpful comments and discussions. All numerical results were obtained using PcGive Professional Version 9.0; see Doornik and Hendry (1996). This paper is a condensed version of Ericsson (1998), which provides additional empirical and analytical examples and more extensive references. The data may be obtained from the Internet at http://wotan.wiwi.hu-berlin.de/oekonometrie/engl/data.html.     

A model of the federal funds market

Summary This paper develops a stochastic general equilibrium model of the federal funds market that incorporates non-Fisherian effects on interest rates stemming from both supply and demand shocks to reserves. Such a model may reconcile the widespread belief in a liquidity effect of money supply shocks with the difficulty many researchers have had in finding empirical support for such an effect. The model also cautions against interpreting the observed negative correlation between the federal funds rate and innovations to nonborrowed reserves as empirical confirmation of the ability of the Federal Reserve to lower short-term real interest rates.This paper should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or its staff. We gratefully acknowledge lengthy discussions and correspondence with V. V. Chari, Marty Eichenbaum, and especially Larry Christiano, that helped to clarify many issues. We were told many institutional details by Jim Clouse and Josh Feinman, and we received many helpful comments from David Altig, Michael Dotsey, and participants at the conference on Recent Research on the Liquidity Effect of Monetary Policy, 1993, Federal Research Bank of Cleveland, the conference on Recent Macroeconomic Research: Lessons for Policymaking, 1993, Federal Reserve Bank of Atlanta and the conference on Operating Procedures and the Conduct of Monetary Policy, 1992, Federal Reserve Bank of St. Louis.     

For they know not what they do: an analysis of monetary policy during the Great Moderation

In this article, we develop an empirical framework to show the importance of money during the Great Moderation, while accounting for the fact that monetary policy was exclusively conducted through interest rates. We estimate the impulse response functions and forecast error variance decomposition derived from a structural VAR with a least absolute shrinkage and selection operator–based lag selection. The variance decomposition suggests that a substantial component of macroeconomic variation has been driven by shocks to the money market, which were not only unintended by the Federal Reserve, but worse passed unnoticed allowing those shocks to accumulate over time.     

The P* model and Austrian prices

In theP ^* model the price level is determined by the money stock per unit of potential out-put and the long-run equilibrium level of the velocity of money. This article applies this model to Austria. Problems in identifying permanent shocks to potential output and/or velocity lead to the rejection of such models of the price level, but their first-difference version is not so suspect. While evidence is found of a long-run relationship between Austria inflation and money growth, even the first-difference version of theP ^* model is rejected for Austria. Since Austria is a small economy, closely tied to Germany, the article also investigates whether Austrian prices are tied to a GermanP ^* measure. This hypothesis is also rejected, but there is a statistically-significant long-run relationship between Austrian and German inflation. Moreover, Austrian money growth remains significant even in this relationship.This article was written while the author was a Visiting Scholar at the Austrian National Bank. The author is indebted to Fritz Breuss, W. Jahnke, and Dieter Proske for help in obtaining the data used here, and for useful discussions about the data, relevant theoretical issues and results. The comments of the referees on an earlier version are also gratefully acknowledged. The views expressed here are those of the author and are not necessarily those of the Austrian National Bank, the Federal Reserve Bank of St. Louis, or the Board of Governors of the Federal Reserve System.     

Stationary solution to the overlapping generations model of fiat money: Experimental evidence

Overlapping generations model of fiat money yields an infinity of competitive equilibrium solutions, only one of which is stationary. Economies reported in this paper involved a sequence of overlapping generations of three or four individuals; each individual lived for two periods. In their young age individuals were endowed with chips that could be traded for fiat money wish the individuals of the old generation. In their old age, individuals could exchange their units o flat money for the consumption good. Results of the experiments exhibit some support for the stationary solution. The results are robust to two designs of exchange institutions (double oral auctior and supply schedule auction) and to two different endogenous ways of converting money into chips at the end of the game (average price prevailing during the last period the game is actually played and the average price forecast made during the last period the game is actually played).A preliminary version of this paper was presented at the meeting of the Economic Science Association and at the Federal Reserve Bank of Minneapolis. The authors are grateful for comments received from various participants at both presentations. Financial support was provided by the McKnight Foundation, the Honeywell Foundation, National Science Foundation (SES 89-12552), and Richard. M. and Margaret Cyert Family Funds.     

Avoiding hyperinflation: Evidence from a laboratory economy

Hyperinflation results from the creation and injection of fiat money into the economy. Using laboratory methods, this paper examines conditions under which fiat money can serve as a medium of exchange in a finite horizon economy while the government is active in the markets for goods. Consistent with the rational expectations hypothesis, issuing new fiat currency does not stabilize a hyperinflation; however, restricting government spending to the amount of tax revenue or reverting to backed money does. These findings are consistent with previous studies of historical data; thus this work confirms those findings from an alternative data source, the laboratory.     

Sufficient conditions for the existence of sunspot equilibria

This paper reports on conditions on agents' preferences and endowments sufficient to guarantee the existence of sunspot equilibria in a simple overlapping generations model of pure exchange. Sunspot equilibria are those in which uncertainty extrinsic to the economy operates through expectations to yield a fulfilled expectations competitive equilibrium in which the extrinsic randomness has real effects on prices and allocations. The paper also provides necessary and sufficient conditions for these equilibria to have agents trading in a fixed stock of valued fiat money. The condition derived can be interpreted as requiring that intertemporal income effects appropriately dominate substitution effects.     

Rate-of-return dominance and efficiency in an experimental economy

Summary. One of the main challenges for monetary economics is to explain the use of assets that are dominated in rate-of-return as media of exchange. We use experimental methods to study how a fiat money might come to be used in transactions when an identically marketable, dividend-bearing asset, a consol, is also available. Our experimental economies, which have an overlapping generations structure, have the property that the only stationary rational expectations equilibria (SREE) require exclusive use of the consol as the medium of exchange. In a baseline treatment, agents use the consol exclusively, as would occur in an SREE. However, in other treatments, we observe episodes of rate-of-return dominance,with consistent use of fiat money as a medium of exchange. The results show that two properties of our economies are associated with the rate of return dominance anomaly. The first is a history of trading with fiat money, prior to the introduction of the consol. The second is the timing of the dividend payment; when the dividend payment follows the execution of trades between generations, hoarding of the consol occurs on the part of the old, who earn dividends by hoarding. In our economies, settling transactions with a dividend-bearing asset does not improve allocations over those resulting from trading with fiat money. Received: July 11, 2002; revised version: July 25, 2002 RID="*" ID="*"We thank Anne Villamil, participants in the 2000 Purdue University Conference on Monetary Economics, the Summer 2000 meetings of the Economic Science Association, and a referee, for very helpful comments. We thank the Krannert School of Management and the Purdue University Center for International Business, Education and Research for financial support and Vivian Lei for research assistance. We also thank Ron Michener for referring us to the historical account of the early introduction of money into the American colonies, as reported by Benjamin Franklin. Correspondence to: G. Camera     

Federal deficits and the conduct of monetary policy

The persistent Federal deficits of the seventies and eighties have been accompanied by economic analysis of those deficits. One conclusion from this work is that deficits force the Federal Reserve to increase the money stock. However, empirical studies have failed to detect this link between deficits and money growth. This article attempts to resolve this contradiction through analysis of the influence of deficits on the instruments actually employed in conducting monetary policy. It is found that persistent deficits do lead to reserve growth but not through the expected interest-rate channel.