The Causes and Consequences of De-Monetizations: A Simple Theory of Inside Money

Xavier Ragot

DELTA Working Papers from DELTA (Ecole normale supérieure)

Abstract: Recent episodes of de-monetization show that private credit can be a substitute for money. This paper studies the conditions of money circulation when non-circulating private debts (IOUs) can be a substitute for money. I first present a simple model of inside money where money circulates if and only if monetary intermediaries have a comparative advantage in debt management. If they loose their comparative advantage, the economy endogenously switches to a non-monetary equilibrium where transactions are paid with private debts. Introducing heterogeneity among agents, I show that the decentralized equilibrium can yield an inefficient outcome: The State can achieve a Pareto superior outcome if it forces money circulation. In some cases, the legal centralization of debt management in the hand of a relatively inefficient agent can improve the welfare of the economy. I show nevertheless that this policy is dominated by a simple optimal mechanism.

Date: 2003
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Persistent link: https://EconPapers.repec.org/RePEc:del:abcdef:2003-10

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