Markets with Fiat
Markets with Fiat
We study markets with fiat as the money. Mathematically speaking, fiat money models reduce to equivalent models using consumable storable money. We discuss the Hahn paradox, whereby in some models with worthless fiat and no loan markets, trade can be extinguished. We then present two models that avoid the Hahn paradox, a no-loan market with a positive salvage value for fiat, and a model with a strategic dummy bank. In the model with banking, we point out that the bank has two types of action: 1) an interest rate strategy whereby it lends whatever amount of money is needed to maintain the interest rate at an exogenously given rho; or 2) a money supply strategy, whereby it lends out the same exogenously given amount of money no matter what. Comparisons are made between otherwise identical models with gold compared with fiat.
Keywords: fiat money, Hahn paradox, interest rate vs money supply, rational expectations, strategic dummy bank
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