This book is about using game theory to model money and financial institutions. Using the backdrop of a simple two-good economy with two continua of traders, we propose a strategic market game to explicitly model the moves that accomplish trade. We then study variations on this simple model, to understand such things as changing the type of money used in the economy (consumable storable money vs gold vs fiat money) and/or the trading structure (buy-sell vs sell all), the role of banks (both central banks and private banks), the market structure for banking (monopoly vs oligopoly vs perfect com ... More

This book is about using game theory to model money and financial institutions. Using the backdrop of a simple two-good economy with two continua of traders, we propose a strategic market game to explicitly model the moves that accomplish trade. We then study variations on this simple model, to understand such things as changing the type of money used in the economy (consumable storable money vs gold vs fiat money) and/or the trading structure (buy-sell vs sell all), the role of banks (both central banks and private banks), the market structure for banking (monopoly vs oligopoly vs perfect competition), bankruptcy, and credit clearinghouses. We are also able to examine the process of a gold demonetization in favor of fiat money. The key feature that allows this is that the players’ decision problems are dynamic, each with a fully defined state space. The physical money is tracked throughout. Hence the players’ optimizations all have inequality constraints reflecting their cash flows. Indeed, our models link the timeless general equilibrium analysis with the fully dynamic complex world around us where the institutions constrain the dynamics. We are able to solve (most of) the models analytically, using the solution concept of (perfect) noncooperative equilibrium. This allows us to perform sensitivity analyses, which show how the “phases” of the economies change as a function of the amount of money in the economy. Finally, we comment throughout the book on how overly simplified the models have to be in order to portray the above phenomena while still being solvable. Hence by themselves they are not realistic. However, they do represent a first step in building a more realistic theory of money and financial institutions.