Rate-of-Return Dominance and Efficiency in an Experimental Economy
32 Pages Posted: 21 Dec 2014
Date Written: July 1, 2002
One of the main challenges for monetary economics is to explain the use of assets that are dominated in rate-of-return as media of exchange.We use experimental methods to study howa fiat money might come to be used in transactions when an identically marketable, dividend-bearing asset, a consol, is also available. Our experimental economies, which have an overlapping generations structure, have the property that the only stationary rational expectations equilibria (SREE) require exclusive use of the consol as the medium of exchange. In a baseline treatment, agents use the consol exclusively, as would occur in an SREE. However, in other treatments, we observe episodes of rate-of-return dominance,with consistent use of fiat money as a medium of exchange. The results show that two properties of our economies are associated with the rate of return dominance anomaly. The first is a history of trading with fiat money, prior to the introduction of the consol. The second is the timing of the dividend payment; when the dividend payment follows the execution of trades between generations, hoarding of the consol occurs on the part of the old, who earn dividends by hoarding. In our economies, settling transactions with a dividend-bearing asset does not improve allocations over those resulting from trading with fiat money.
Keywords: Experimental overlapping generations model, Monetary equilibrium, Rate of return dominance.
JEL Classification: C92, E42
Suggested Citation: Suggested Citation
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