ABSTRACT
Nominal contracts are typically assumed to bind whenever trade occurs. This paper shows that nominal contracts may fail to bind in equilibrium even in the absence of inflation volatility, liquidity shortages, or price rigidities, once enforceability becomes state contingent. The mechanism operates through the credibility of the unit of account, which is modeled as a rule governing the mapping from nominal promises to real allocations rather than as an exogenous numéraire. I develop a framework in which the bindingness of nominal promises varies across states, generating equilibrium regimes with partial or complete contract failure. These regimes produce welfare losses driven by tail infeasibility of nominal promises, even when prices adjust and liquidity remains abundant. The results identify a margin of monetary failure that is distinct from the channels emphasized in search-theoretic, price-based, and volatility-centered models.
Lewarne, Stephen, When Contracts Do Not Bind: Money, Institutional Volatility, and the Unit of Account (January 25, 2026).
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