Counterfeit quality and verification in a monetary exchange

- We study counterfeiting of currency in a competitive search environment.
- Counterfeiting can occur in a monetary equilibrium if the cost of produce counterfeits is sufficiently low.
- A higher rate of inflation tends to reduce counterfeiting.
- A single anti-counterfeiting measure may not deter counterfeiting due to the interaction between sellers and counterfeiters.
- It provides an rationale why the policy maker needs to combine different anti-counterfeiting measures.

Recent studies on counterfeiting in a monetary search framework show that counterfeiting does not occur in a monetary equilibrium. These findings are contrary to the observation that counterfeiting of bank notes in some countries has recently experienced rapid increases. In this paper, we construct a model of counterfeiting in which counterfeiting can exist as an equilibrium outcome. A competitive search environment is employed in which sellers post offers and buyers direct their search based on posted offers. When sellers are uninformed, their offers are pooling and thus buyers can extract some rents by using counterfeit money. Therefore, counterfeit notes can coexist with genuine notes under certain conditions. We also explicitly model the interaction between sellers' verification decisions and counterfeiters' choices of counterfeit quality. This allows us to better understand how policies can affect counterfeiting.