Working Paper 516

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Government Transaction Policy, the Medium of Exchange, and Welfare

S. Rao Aiyagari
Neil Wallace - Consultant

Revised June 1, 1995

Abstract
An interpretation of government policy regarding what it accepts in transactions is embedded in a version of the Kiyotaki-Wright model of media of exchange. In an example with two goods and one fiat money, the policies consistent with fiat money being the unique medium of exchange are identified. These uniqueness policies have the government favoring fiat money in its transactions. Benefits and costs accompany any such policy. The benefit is that a worse nonmonetary equilibrium is eliminated; the cost is that a better monetary equilibrium is also eliminated.


Published In: Journal of Economic Theory (Vol. 74, No. 1, May 1997, pp. 1-18)

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