Fiat Money and Coordination: a “perverse” Coexistence of Private Notes and Fiat Money

Recently there has been renewed interest in coordination problems, and, in particular, in monetary aspects of coordination. This paper attempts to combine important insights developed in the literature on matching models of money (in particular Kiyotaki and Wright [1989], Kocherlakota [1998] and Cavalcanti and Wallace [1999]) with insights from the macroeconomic coordination game-technological complementarity literature (in particular see Cooper [1999] and Cooper and Corbae [2001]). Taken together, these two related literatures may yield further insight into the relationship between production coordination and outside fiat money, and, thereby, into the coexistence of private notes and outside fiat money. One important old insight, but which has been refined lately (see Kocherlakota [1998]), is that money is imperfect information. Further, one simple specification of incomplete information in particular, which has proven fruitful in motivating outside fiat money in matching environments, is to assume that agents are unidentifiable (see Cavalcanti and Wallace [1999]). This paper adopts this approach. In earlier work, it has also been argued that outside money has a direct role to play in production coordination itself. This is not surprising as imperfect information is also an ingredient in production coordination failure. Indeed, the use of currency may facilitate production coordination. For example, Bryant [2002] argues that (historically observed) indemnification with gold may have facilitated coordination in bills of exchange markets. On the other hand, this paper considers another, and very different, possible aspect of the relationship between outside money and production coordination, in a matching model of incomplete information. Outside fiat money can actually have its very demand induced by the anticipation and realization of a production coordination failure that, in self-fulfilling fashion, its own existence facilitates! Moreover this “perverse” demand for outside fiat money coexists with private notes.