Currency restrictions, government transaction policies and currency exchange

Summary.

We study how currency restrictions and government transaction policies affect the values of fiat currencies in a two country, divisible good, search model. We show that these policies can generate equilibria where both currencies circulate as medium of exchange and where currency exchange occurs between citizens of different countries. Restrictions on the internal use of foreign currency can cause the domestic currency to be relatively more valuable to domestic agents while taxes on domestic currency create an incentive for home agents to hold foreign currency. We demonstrate that some policies increase prices and lower welfare while others do the reverse.