Discussion Paper

Electronic money: the end of inflation?

Abstract: We study economies where government currency and electronic money, drawn from interest bearing deposits in private financial intermediary institutions, are full substitutes. We analyze the impact of competition on policy outcomes under different assumptions regarding: the objectives of the central bank, the ability of the monetary authorities to commit to future policies, and the legal restrictions in the form of reserve requirements on financial intermediaries. Electronic money competition can discipline a revenue maximizing government and result in lower equilibrium inflation rates, even when there is imperfect commitment. The efficient Friedman rule policy, of zero nominal interest rates, is only implemented if the government maximizes households preferences, in which case, electronic money competition may either have no role, or weaken the incentive effects of the reputational mechanism. We also show how an independent choice of the reserve requirements can be an effective policy rule to enhance the disciplinary role of electronic money competition.

Keywords: Money; Inflation (Finance);

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Discussion Paper / Institute for Empirical Macroeconomics

Publication Date: 1997

Number: 122