Friday, August 19, 2011

Trust in private money

Money does not have to be supplied by government. Private money could work under some circumstances, and it has in particular been argued that competition should be beneficial. While previous attempts have failed, the wider availability of information, rating agencies (gasp) and information technology could make it happen. So it is of interest to find out what those circumstances are.

Ramon Marimon, Juan Pablo Nicolini and Pedro Teles say that money is an experience good, as you only observes its quality after the exchange is performed. This leads to serious limitations. If issuer of currency cannot commit to not inflate in the future, then competition over currency in the present has no bite. Building a reputation can solve this to some degree, but building the necessary trust means that future rewards must be larger that immediate gains from inflating. That implies that full efficiency cannot be attained: inflation needs to remain positive, while full efficiency implies negative inflation so that money has the same return as a risk-free bond. Unfortunately it also implies that there is indeterminacy and any inflation rate could happen. Oh well, may be the government could step in to help achieve efficiency...

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