“Welfare Improvement from Restricting the Liquidity of Nominal Bonds” by Shouyong SHI
University of Toronto
In this paper I examine whether a society can improve welfare by imposing a legal restriction to forbid the use of nominal bonds as a means of payments for goods. To do so, I integrate a microfounded model of money with the framework of limited participation. While the asset market is Walrasian, the goods market is decentralized and the legal restriction is imposed only in a fraction of the trades. I show that the legal restriction can improve the society’s welfare. In contrast to the literature, this essential role of the legal restriction persists even in the steady state and it does not rely on households’ ability to trade unmatured bonds for money after observing the taste (or endowment) shocks.