Introducing a new currency: Government policy and prices

The aim of this article is to study the introduction of a new fiat currency within a dual-currency divisible goods search model. The government (using price control or legal tender laws) can affect the equilibrium price levels of two domestic currencies, with the goal of driving the old currency out of circulation and replacing it with a new one. It is shown that some equilibrium solutions that exist in a laissez-faire environment disappear with government monitoring. Additionally, when the old currency is made illegal, its equilibrium value is affected differently by public measures such as conversion, tax and redistribution policies. Finally, if the enforcement power of legal tender laws is strong enough, the old currency cannot be more valuable than the new one, and the probability that it changes hands in trade, when introducing lotteries, cannot be smaller than one. (C) 2004 Elsevier B.V. All rights reserved.