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Fiat money and the value of binding portfolio constraints


We establish necessary and sufficient conditions for the individual optimality of a consumption-portfolio plan in an infinite horizon economy where agents are uniformly impatient and fiat money is the only asset available for intertemporal transfers of wealth. Next, we show that fiat money has a positive equilibrium price if and only if for some agent the zero short sale constraint is binding and has a positive shadow price (now or in the future). As there is always an agent that is long, it follows that marginal rates of intertemporal substitution never coincide across agents. That is, monetary equilibria are never full Pareto efficient. We also give a counter-example illustrating the occurrence of monetary bubbles under incomplete markets in the absence of uniform impatience.

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Corresponding author

Correspondence to Juan Pablo Torres-Martínez.

Additional information

Previous working paper versions of this article appeared under the titles: “On the role of debt constraints in monetary equilibrium” and “Welfare improving debt constraints”. Although in this article we avoid short-sales of money, more general debt constraints were studied in the previous working paper versions (see, for instance, Páscoa, Petrassi and Torres-Martínez (2008)). M. Petrassi wants to disclaim that the views expressed in this work do not necessarily reflect those of the Banco Central do Brasil or its members.

We are grateful to the Co-Editor Timothy Kehoe and two anonymous referees for their insights and suggestions. Mário R. Páscoa acknowledges support from FCT and FEDER (project PTDC/ECO/64968/2006). J.P. Torres-Martínez acknowledges support from the Brazilian research council, CNPq, through project 307554/2004-0. Petrassi and Torres-Martínez also want to thank the Department of Economics, PUC-Rio, Brazil, where this research was partly undertaken.

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Páscoa, M.R., Petrassi, M. & Torres-Martínez, J.P. Fiat money and the value of binding portfolio constraints. Econ Theory 46, 189–209 (2011).

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  • Binding portfolio constraints
  • Fundamental value of money
  • Asset pricing bubbles

JEL Classification

  • D50
  • D53
  • E41
  • E44