A Theory of Money, Prices, and the Rate of Interest. Part III. The Rate of Interest on Fiat Money in a Closed Economy.

by Martin Shubik

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In a well-controlled, competitive monetary economy with no uncertainty, there are no idle cash balances--they are needed for current transactions or are loaned. The presence of uncertainty calls for the holding of cash. In a trading economy with perfect foresight, without taxes, but with traders having positive time discounts, the rate of interest on paper money is positive. With uncertainty, fiat money is a form of insurance or generalized futures contract. The mathematical differences among static general equilibrium theory, a theory of money in a static general equilibrium context with perfect foresight, and an evolutionary system are essentially those among maximization subject to equalities: convex programming and dynamic programming. Inflation or deflation are consistent with an equilibrium distribution of real resources and the appropriate rate of interest, taxation, and money-issue policy. 60 pp. Ref. (See also P-4686, P-4699.) (Author)

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