Currency competition

Competing currencies can limit the ability of the central bank to use the interest rate as a policy instrument; they can also restrict the attainable equilibrium inflation rate. In a market with free entry for multiple currencies with profit maximizing issuers, the central bank completely loses control of the interest rate and the inflation rate, which both come to be determined by structural factors (rate of time preference, entry cost, exit rate).

Although currency competition creates problems for monetary policy implementation under conventional methods, it is possible to design a policy rule that uniquely implements an efficient allocation. We also show that unique implementation of an efficient allocation can be achieved without government intervention if productive capital is introduced.