Why fiat money is a safe asset

Dirk Paulsen

Economics Letters, 2012, vol. 116, issue 2, 193-198

Abstract: This paper presents a model in which (1) fiat money has strictly positive value in the unique trembling hand equilibrium. This holds as each bank note is both: (a) a witness for the existence of some agent in the economy with debt, backed by collateral, and (b) the only matter that allows the debtor to settle her debt. The fear to lose the collateral creates future money demand by the debtor and thereby ensures positive money value. (2) Money is a safe asset as not only a single but all debtors in the economy demand money so that idiosyncratic shocks to solvency wash out. By this mechanism, fiat money is essentially equivalent to large securitized pools of debt which (3) can establish the pooling allocation even if pooling itself is infeasible.

Keywords: Fiat money; Securitization; Safe asset; Collateral (search for similar items in EconPapers)
JEL-codes: E40 E50 (search for similar items in EconPapers)
Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:116:y:2012:i:2:p:193-198

DOI: 10.1016/j.econlet.2012.02.016

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