Money Shortages and Complementary Currencies in Small Local Economies

ABSTRACT

This paper rationalizes the adoption of a complementary currency (CC) in a small, local economy. A local money shortage occurs when the supply of official currency, determined endogenously by trade with a larger economy, falls short of the liquidity needed for first‐best activity. A CC then supplements liquidity and boosts local trade at the expense of external trade; the welfare‐maximizing CC supply is strictly positive. A calibration to coca‐growing villages in Colombia, where coca‐base circulates as a local CC, suggests its liquidity role raises local trade by roughly a third.