IMPERFECT MONITORING AND THE DISCOUNTING OF INSIDE MONEY* |
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| Authors: | David C Mills Jr |
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| Institution: | 1. Federal Reserve Board, U.S.A.;2. The author thanks Travis Nesmith, Geoff Gerdes, Will Roberds, and seminar participants at Iowa State University, Texas A & M University, the 2006 Winter Meetings of the Econometric Society in Boston, the Midwest Macroeconomics Meetings at Washington University, the Federal Reserve Bank of Cleveland's Workshop on Money, Banking and Payments, and the Midwest Economic Theory Meetings at Vanderbilt University for comments and suggestions. The author also thanks Daniel Dube for valuable research assistance. All errors are the responsibility of the author. The views in this article 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 or of any other person associated with the Federal Reserve System. Please address correspondence to: David C. Mills, Federal Reserve Board, Mail Stop 188, Washington, DC 20551. Phone: 202 5306265. E‐mail: . |
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| Abstract: | This article evaluates the efficiency of a requirement that private issuers redeem inside money on demand at par in a random‐matching model of money where the issuers of inside money are imperfectly monitored. I find that for sufficiently imperfect monitoring, a par redemption requirement leads to lower social welfare than if private money were redeemed at a discount. A central message of the article is that if inside money and outside money are not perfect substitutes, a par redemption requirement may not be socially optimal because such a requirement effectively binds them to circulate as if they are. |
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