Working Paper BETA #2008-12

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Title : Modelling the transaction role of money and the essentiality of money in a hyperinflation context

Author(s) : Alexandre Sokic

Abstract : This paper uses an analytical approach and the precise definition of money essentiality given by Scheinkman (1980) with the aim to establish a formal theoretical link between the possibility of hyperinflationary paths and the concept of money essentiality. In this respect the paper contributes to the understanding of the well known failure of Cagan based inflationary finance models to produce explosive hyperinflation. We consider two standard optimizing monetary models representing alternative ways of modelling the transaction role of money. The paper considers a money-in-the-utility-function model and a cash-in-advance model where representative agent’s preferences are represented by general utility functions. We show that modelling monetary hyperinflation with perfect foresight is closely linked to the concept of money essentiality as defined by Scheinkman (1980). The possibility of explosive monetary hyperinflation in a perfect foresight inflationary finance model always relies on a sufficient level of money essentiality. The main contribution of this paper is to show that, whether in a cash-in-advance or in a money-in-the-utility-function framework, this sufficient level of money essentiality does not depend on the specific way, cash-in-advance or moneyin- the-utility-function, of modelling the role of money as a medium of exchange.

Key-words : monetary hyperinflation, inflation tax, money essentiality.

JEL Classification : E31, E41