On the coexistence of money and higher-return assets and its social role

This paper adopts mechanism design to investigate the coexistence of …at money and higherreturn assets. We consider an economy with pairwise meetings where …at money and riskfree capital compete as means of payment, as in Lagos and Rocheteau (2008). The trading mechanism in pairwise meetings is chosen among all individually rational, renegotiation-proof mechanisms to maximize society’s welfare. We show that in any stationary monetary equilibrium capital commands a higher rate of return than …at money. JEL Classi…cation: D82, D83, E40, E50 Keywords: money, capital, pairwise trades, rate-of-return dominance We thank Neil Wallace, an associate editor, and two anonymous referees for their comments on an earlier draft. We also bene…ted from the comments of seminar participants at Queen’s University, the University of California at Davis and Santa Barbara, the University of Paris 2, the Federal Reserve Bank of Cleveland, the Federal Reserve Bank of Philadelphia, the Getulio Vargas Foundation, the second Summer Workshop in Macro Finance at Science-Po Paris, the Money, Banking, and Finance Summer Workshop at the Federal Reserve Bank of Chicago, and the West Coast Search-and-Matching Worskhop at UC Santa Cruz. We thank Monica Crabtree-Reusser for editorial assistance. E-Mail: [email protected].