Nominal Exchange Rate Determinacy Under the Threat of Currency Counterfeiting

Pedro Gomis-Porqueras, Timothy Kam and Christopher Waller

No 2015-28, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We study the endogenous choice to accept fiat objects as media of exchange and their implications for nominal exchange rate determination. We consider a two-country environment with two currencies which can be used to settle any transactions. However, currencies can be counterfeited at a fixed cost and the decision to counterfeit is private information. This induces equilibrium liquidity constraints on the currencies in circulation. We show that the threat of counterfeiting can pin down the nominal exchange rate even when the currencies are perfect substitutes, thus breaking the Kareken-Wallace indeterminacy result. When the two currencies are not perfect substitutes, an international currency can exist whereby one country has two currencies circulating while the other country uses only one. We also find that with appropriate fiscal policies we can enlarge the set of monetary equilibria with determinate nominal exchange rates. Finally, we show that the threat of counterfeiting can also help determine nominal exchange rates in a variety of different trading environments.

Keywords: Multiple Currencies; Counterfeiting Threat; Liquidity; Exchange Rates (search for similar items in EconPapers)
JEL-codes: D82 D83 E4 F4 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2015-06-20
New Economics Papers: this item is included in nep-mon and nep-opm
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Citations: View citations in EconPapers (1)

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Journal Article: Nominal Exchange Rate Determinacy under the Threat of Currency Counterfeiting (2017)
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DOI: 10.20955/wp.2015.028

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