Imperfect monitoring and the discounting of inside money

David Mills ()

No 2007-58, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: One of the fundamental questions concerning inside money is whether its issuers should be regulated and how. This paper evaluates the efficiency of one prevalent regulatory recommendation -- a requirement that private issuers redeem inside money on demand at par -- in a random-matching model of money where the issuers of inside money are only imperfectly monitored. I find that for sufficiently imperfect monitoring, a par redemption requirement leads to lower social welfare than if private money were redeemed at a discount. A central message of the paper is that if inside money and outside money are not perfect substitutes for one another, as is the case if there is sufficiently imperfect monitoring, a par redemption requirement may not be socially optimal because such a requirement effectively binds them to circulate as if they are. Such an outcome is a version of Gresham's law that bad money drives out good money.

Keywords: Money; Econometric models (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Related works:
Journal Article: IMPERFECT MONITORING AND THE DISCOUNTING OF INSIDE MONEY (2008)
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