Currency Competition: A Partial Vindication of Hayek

Abstract

This paper establishes the existence of equilibria for environments in which outside money is issued competitively. Such equilibria are typically believed not to exist because of a classic overissue problem: if money is valued in equilibrium, an issuer produces money until its value is driven to zero. By backward induction, money cannot have value in the first place. However, for any given finite amount of money outstanding, a monetary economy typically has two equilibria. In one, money has value; in the other, money is not valued because no one expects it to be valued. This paper takes this latter equilibrium seriously and shows that trigger strategies eliminate the overissue problem if agents have beliefs of the following type: if an issuer produces money beyond some threshold amount, then the issuer's money has no value. This result is very general, applying to any monetary economy in which equilibria with and without valued money exist if the money supply is finite. The paper also compares the allocation achieved by a monopolist to that achieved with competitive issuance in both a search and an overlapping-generations environment. The results depend on the environment considered, but two general conclusions arise. First, it is ambiguous whether competitive issuers can achieve a more desirable allocation than a monopolist. Second, with competitive issuance, a licensing agency can always improve on pure laissez-faire and achieve the efficient allocation in the long run.