Non-Technical Summary
The paper develops a general framework to understand how a state can influence the value of its currency—specifically, the price level—through its financial policies. It focuses on two key roles of money: as legal tender for settling obligations between the state and private agents, and as an official medium of exchange in transactions with the state. The central question is whether these roles alone can determine a unique price level in the economy.
In the model, all agents—including the state—are price-setters. The state can issue money, levy taxes, and trade goods for money at prices it chooses. Private agents can also trade among themselves, potentially at prices that differ from official ones. The authors show that, under certain conditions, the state’s policy can lead to a unique and predictable price level. However, when these conditions are not satisfied, multiple price levels may coexist, including unofficial or parallel markets.
A key insight is that price-level determination depends not only on the state’s declared price but also on its willingness to trade enough goods or money. When the state’s backing is too limited, agents with privileged access to official markets can exploit their position by trading in unofficial markets, generating price dispersion and redistribution effects.
The framework also captures regimes of fiscal dominance, in which the state issues money to meet its obligations regardless of inflationary consequences. Conversely, under monetary dominance, the central bank controls the price level while the government adjusts its fiscal stance. The paper also examines intermediate cases where neither side fully accommodates the other, leading to instability and multiple equilibria.
Applications include historical episodes such as the assignats during the French Revolution, modern exchange-rate pegs, price controls, and the behavior of stablecoins and money market funds. The model helps explain the emergence of parallel markets and how agents with privileged access can extract rents. Finally, it sheds light on debt-deflation dynamics and the conditions under which monetary policy can restore price stability.
In the context of stablecoins, our framework predicts that heterogeneous access to the official market—the primary venue where retail investors can exchange stablecoins for bank deposits with issuers—combined with insufficient backing (or expectations thereof) can lead to price fragmentation and eventual de-pegging. This dynamic was observed during the failure of Silicon Valley Bank in March 2023, where intermediaries exploited their privileged access to convert stablecoins into fiat currencies. These events illustrate that, although our core implications concern official currencies, the framework also provides valuable insights for privately issued monies such as stablecoins and money market funds.
Overall, the paper argues that traditional Walrasian models are ill-suited to capture the strategic and institutional complexities of price-level determination. Instead, it advocates a game-theoretic framework that accounts for out-of-equilibrium behavior and explicit policy mechanisms, offers richer and more realistic insights into monetary and fiscal interactions.
Keywords: Price Level Determination; Legal Tender; Monetary Policy; Fiscal Policy
Codes JEL : E42, E52, E58