CIRJE-F-363 | "A Theory of International Currency and Seigniorage Competition" |
Author Name | Li, Yiting and Akihiko Matsui |
Date | September 2005 |
Full Paper | PDF file@ |
Remarks | @ |
Abstract |
This paper explicitly considers strategic interaction between governments to study currency
competition and its effects on the circulation of currencies and welfare in a two-country,
two-currency search theoretic model. Each government uses seigniorage to provide public
goods. Agents consume private goods, and the public goods of their own country. We have
several findings. The negative impact of a country's inflationary policy on the realm of
circulation of its currency imposes an inflation discipline: the more open a country is, the
stronger is the discipline. The worldwide circulation of a currency increases seigniorage and
welfare and decreases the inflation rate of the issuing country compared to autarky. The
other country, since the tax base is reduced due to the use of foreign currency, raises its
inflation rate. However, there is a limit on the rate beyond which it cannot maintain the
circulation of national money. Under strategic interaction between governments in selecting
equilibrium, the larger country would try to lower the inflation rate to make its currency
circulate abroad, while the other country may also lower the inflation rate to sustain its
national currency as the sole medium of exchange. |