Recognizability of medium of exchange and relative prices

Abstract

This paper provides a theoretical account for the fundamental defects of commodity money as an imperfectlyrecognizable medium of exchange. We incorporate the recognizability of silver as a medium of exchange explicitly into the search-based model where silver can be either used as a medium of exchange or invested in the world market for a given rate of return. When the recognizability of silver becomes severe, both the real balance of silver as a medium of exchange and the quantity traded decrease substantially. The declining real balance of silver is due to either a decrease in the nominal balance of silver when silver is abundant or a decrease in the price of silver when silver is scarce. The variability of silver demand and price also affects relative prices as long as silver coin is used as an imperfectly-recognizable medium of exchange. An increase in the recognizability of silver improves welfare through its effects on extensive and intensive margins, net of opportunity cost of holding nominal balance of silver for a trade. This implies the superiority of fiat money which is almost perfectly recognizable.