Breaking the Curse of Cash

30 Pages Posted: 29 Apr 2018 Last revised: 10 Jun 2018

Joshua R. Hendrickson

University of Mississippi; American Institute for Economic Research

Jaevin Park

University of Mississippi - Department of Economics

Date Written: April 11, 2018

Abstract

Can eliminating paper money improve social welfare? We construct a dual currency model to study whether illegal activity can be reduced or eliminated by modifying the payment environment. In our model, there are two types of money, coins and paper money, and two types of goods, legal and illegal. Legal (goods) traders are ex ante indifferent between coins and paper money, but illegal (goods) traders prefer paper money to coins because illegal activities can be detected by the noise of the coins. Eliminating paper money can improve social welfare by reducing illegal activity. However, this pooling equilibrium is suboptimal when government finance is restricted. Given the government budget constraint, a separating equilibrium in which legal traders use coins and illegal traders use paper money, can improve welfare by making a transfer from the illegal traders to the legal traders.

Keywords: Dual Currency, Seigniorage, Externality

JEL Classification: D62, E26, E52

Suggested Citation

Hendrickson, Joshua R. and Park, Jaevin, Breaking the Curse of Cash (April 11, 2018). Available at SSRN: https://ssrn.com/abstract=3160989 or http://dx.doi.org/10.2139/ssrn.3160989

Joshua R. Hendrickson (Contact Author)

University of Mississippi ( email )

Oxford, MS 38677
United States

American Institute for Economic Research

PO Box 1000
Great Barrington, MA 01230
United States

Jaevin Park

University of Mississippi - Department of Economics ( email )

371 Holman Hall
University, MS 38677
United States

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