Private Supply of Fiat Money

The question of whether private money is viable in the absence of any external control is an old one. We address it in an economy with decentralized trade and information where a self-interested agent, the bank, has the monopoly over the provision of fiat money and is not limited on how much it can issue over time. The assumption of decentralized information is a crucial one and sets this work apart from all previous investigations in the literature. We argue below that the latter is a necessary assumption if one wants to capture the absence of any external limits on the bank’s behavior. We first show that if the bank can commit to a choice of money supply, a monetary equilibrium with no overissue exists. This equilibrium, however, is not time-consistent, and so does not survive when no commitment is possible for the bank. In fact, we show that with no commitment, the only monetary equilibria possible have overissue happening infinitely many times. We finish by showing how this time-consistency problem can be solved. JEL Classification: D82, D83, E00