Staff Report 341

Money and Capital as Competing Media of Exchange

Ricardo Lagos | Consultant
Guillaume Rocheteau

Published August 1, 2004

We construct a model where capital competes with fiat money as a medium of exchange, and we 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.

Published In: Journal of Economic Theory (Vol. 142, No. 1, September 2008, pp. 247-258)

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