Limited Commitment and the Legal Restrictions Theory of the Demand for Money

Leo Ferraris () and Fabrizio Mattesini

No 262, CEIS Research Paper from Tor Vergata University, CEIS

Abstract: This paper addresses the "rate of return" puzzle of monetary theory. Similarly to the legal restrictions theory of the demand for money, we assume that Government bonds are subject to a minimum purchase requirement. Differently from this theory, however, we assume that intermediaries, when issuing private notes, cannot commit to always redeem them. First, we study an environment with legal restrictions to intermediation and show that cash and interest bearing bonds both circulate in the economy. Then, we drop the legal restrictions and show that also with active intermediation, under limited commitment, there is an equilibrium with rate of return dominance. A positive interest rate provides the intermediaries with the incentive to issue and redeem their notes.

Keywords: Money; Government Bonds; Rate of Return Dominance; Legal Restrictions (search for similar items in EconPapers)
JEL-codes: E40 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2013-01-21, Revised 2013-01-21
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (2)

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Journal Article: Limited commitment and the legal restrictions theory of the demand for money (2014)
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