Keywords: Inside and outside money
Abstract: I present an environment for which both outside and inside money are essential as means of payment.
The key model feature is that there is imperfect monitoring of issuers of inside money. I use a random
matching model of money where some agents have private trading histories and others have trading histories
that can be publicly observed only after a lag. I show via an example that for lags that are neither too
long nor too short, there exist allocations that use both types of money that cannot be duplicated when
only one type is used. Inside money provides liquidity that increases the frequency of trades, but incentive
constraints restrict the amount of output that can be traded. Outside money is immune to such constraints
and can trade for higher levels of output.
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Last update: November 9, 2006