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Why fiat money is a safe asset

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  • Paulsen, Dirk

Abstract

This paper presents a model in which (1) fiat money has strictly positive value in the unique trembling hand equilibrium. This holds as each bank note is both: (a) a witness for the existence of some agent in the economy with debt, backed by collateral, and (b) the only matter that allows the debtor to settle her debt. The fear to lose the collateral creates future money demand by the debtor and thereby ensures positive money value. (2) Money is a safe asset as not only a single but all debtors in the economy demand money so that idiosyncratic shocks to solvency wash out. By this mechanism, fiat money is essentially equivalent to large securitized pools of debt which (3) can establish the pooling allocation even if pooling itself is infeasible.

Suggested Citation

  • Paulsen, Dirk, 2012. "Why fiat money is a safe asset," Economics Letters, Elsevier, vol. 116(2), pages 193-198.
    • Handle: RePEc:eee:ecolet:v:116:y:2012:i:2:p:193-198
    DOI: 10.1016/j.econlet.2012.02.016
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    References listed on IDEAS

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    1. Jean-Michel Grandmont & Yves Younes, 1972. "On the Role of Money and the Existence of a Monetary Equilibrium," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 39(3), pages 355-372.
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    4. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
    5. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March.
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    More about this item

    Keywords

    Fiat money; Securitization; Safe asset; Collateral;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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