Fiat Money as a Public Signal, Medium of Exchange, and Punishment

Abstract

This paper studies different welfare-enhancing roles that fiat money can have. To do so, we consider an indivisible monetary framework where agents are randomly and bilaterally matched, while the government has weak enforcement powers. Within this environment, we analyze state contingent monetary policies and characterize the resulting equilibria under different government record-keeping technologies. We show that a threat of injecting fiat money, conditional on private actions, can improve allocations and achieve efficiency. This type of state contingent policy is effective even when the government cannot observe any private trades and agents can only communicate with the government through cheap talk. In all these equilibria fiat money and self-enforcing credit are complements in the off equilibrium. Finally, this type of equilibria can also emerge even when the injection of fiat money is not a public signal.

Raising Interest Rates for Improving Income

“…In the case of low interest rates, usual prices policies are less effective, but Quantitative Easing (QE) may be a good substitute (Kiley, 2018). Some authors have considered the viability of an optimal positive quantity of money issue by central bankers (Friedman, 1969, Gomis-Porqueras & Sun, 2020.…”