On the Publicness of Fiat Money

  • Thomas K. Rymes


Jack Weldon1 wrote on money as a public good.2 Peter Howitt, in the New Palgrave, addresses the problem.3 Ten years before Howitt, David Laidler had also turned to the same theme.4 Like them, I take up Weldon’s question.


Monetary Policy Price Level Money Supply Real Rate Monetary Authority 
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Notes and References

  1. 1.
    Professor J. C. Weldon supervised my McGill thesis, submitted in the summer of 1968 as ‘On the Theory and Measurement of Capital’ and subsequently published as On Concepts of Capital and Technical Change (Cambridge: Cambridge University Press, 1971). He ran faculty seminars on monetary theory which I attended while a visiting lecturer at McGill from 1972 to 1975. The seminars, led by Weldon with brilliance and wit, were a great delight, where the freest and sharpest exchange of scholarly views could occur without being accompanied by the vicissitudes which sometime mar academic life. This chapter is written, then, in memory of Jack Weldon, the scholarly guidance he provided, and the monetary seminars he led at McGill. I am grateful for comments on an earlier draft by Jack Galbraith, John Smithin and the editors of this volume.Google Scholar
  2. 2.
    His first work was published as ‘Theoretical Penalties of Inflation’, eds N. Swan and D. Wilton, Inflation and the Canadian Experience (Kingston: Industrial Relations Centre at Queen’s University, 1971) [Weldon, 1971]. The second was ‘On Money as a Public Good’ (McGill University, mimeo 2 June 1973), a paper presented to 1973 meetings of the Canadian Economics Association [Weldon, 1973]. In the second paper, Professor Weldon allowed as how it was the third version of the theme, the first ‘tentatively offered to a seminar at Carleton, in 1968 I think’. Alas, there is no trace of Weldon giving the seminar at Carleton nor of the paper he gave at the time.Google Scholar
  3. 3.
    Peter Howitt, ‘Optimum Quantity of Money’, The New Palgrave Dictionary, III (London: Mcmillan, 1987).Google Scholar
  4. 4.
    David Laidler, ‘The Welfare Cost of Inflation in Neoclassical Theory — some unsettled problems’ ed. E. Lundberg, Inflation Theory and Anti-Inflation Policy (Boulder, Colorado: Westview Press, 1977). Professor Laidler has returned recently to the problem. See D. Laidler, ‘Taking Money Seriously’, Canadian Journal of Economics, 21 (November 1988) pp. 687–713, and ‘Monetarism, Microfoundations and the Theory of Monetary Policy’, University of Western Ontario Working Paper 8807C.Google Scholar
  5. 5.
    See Weldon, 1973, pp. 12–13, especially footnote 24, and, in particular, his discussion with Professor Robert Mundell in the section on interest-yielding money in ‘Inflation, Saving, and the Real Rate of Interest’, in Mundell’s Monetary Theory (Pacific Palisades: Goodyear Publishing Company, 1971).Google Scholar
  6. 6.
    See, however, Thomas K. Rymes, ‘The Logical Impossibility of Optimum Money Supply Policies’, Carleton Economic Papers 72-15; Jon Harkness, ‘The Neutrality of Money in Neoclassical Growth Models’, The Canadian Journal of Economics, 11 (November 1978) pp. 701–13; and John N. Smithin, ‘A Note on the Welfare Cost of Perfectly Anticipated Inflation’, Bulletin of Economic Research, 35 (May 1983) pp. 65–9.CrossRefGoogle Scholar
  7. 7.
    See A. Asimakopulos and J. C. Weldon, ‘A Synoptic View of Some Simple Models of Growth’, Canadian Journal of Economics and Political Science, 31 (February 1965) pp. 52–79.CrossRefGoogle Scholar
  8. 8.
    For an example of such a model, see R. Dornbusch and J. Frenkel, ‘Inflation and Growth: Alternative Approaches’, Journal of Money, Credit and Banking, 5 (February 1973) pp. 141–56. For an earlier version of part of the argument of this paper, see Thomas K. Rymes, ‘Keynes and Stable Money’, ed. O. Hamouda and J. Smithin, Keynes and Public Policy After Fifty Years, II (Aldershot, Hants: Edward Elgar, 1988), and for an extension of the argument to include banking see my The Theory and Measurement of the Nominal Output of Banks, Sectoral Rates of Savings and Wealth in the National Accounts’, eds. Robert Lipsey and Helen Stone Tice, The Measurement of Saving, Investment, and Wealth (Chicago: University of Chicago University Press for the NBER, Inc., 1989).CrossRefGoogle Scholar
  9. 9.
    The Bank of Canada reports (See Bank of Canada, Press Statement, 14 March 1986, contained in its The Story of Canada’s Currency (Ottawa, 3rd ed 1981)) that one of its bank notes costs in the order of six cents to produce and handle. If one were talking about the production of a $1.00 bank note then a production cost of six cents is in no way negligible. If it is assumed, however, that the cost of a $10.00 bank note is also six cents then the cost of increasing the nominal stock of bank notes from one $1.00 note to one $10.00 note is zero. Thus, if the nominal stock of bank notes were increased in Canada by replacing one-dollar notes with ten-dollar notes, two-dollar notes with twenties, fives with fifties, and so forth, the reproduction cost of the stock of bank notes would remain unchanged while the nominal value of the stock of fiat currency would have been increased tenfold.Google Scholar
  10. 10.
    Such propositions were discussed by Marshall in his Essay on Money when he wrote (circa 1871) about an individual choosing between holding horses and money. See the Essay on Money in ed. J. K. Whitaker, The Early Writings of Alfred Marshall 1867–1890, I (London: Macmillan for The Royal Economic Society, 1975, p. 167) and were developed further by Keynes, under the influence of Sraffa, in ‘The Essential Properties of Interest and Money’, in his The General Theory of Employment, Interest and Money, Collected Writings of John Maynard Keynes, VII (London: Macmillan for the Royal Economic Society, 1973). See Carlo Panico, ‘Sraffa on Money and Banking’, Cambridge Journal of Economics, 12 (March 1988) pp. 7–28, for a discussion of Sraffa’s influence on Keynes.Google Scholar
  11. 11.
    Lucas argues (S402) ‘Technically, I think of economics as studying decision rules that are steady states of some adaptive process, decision rules that are found to work over a range of situations and hence are no longer revised appreciably as more experience accumulates.’ Robert E. Lucas, Jr., ‘Adaptive Behaviour and Economic Theory’, Journal of Business, 59 (October 1986) pp. S401–S426.CrossRefGoogle Scholar
  12. 12.
    Consider a lower price level which will be associated with a larger stock of ‘real’ money balances and a lower gross marginal physical product of the services of such ‘real’ money balances. Since the stock of ‘real’ money balances is greater, with the stock of capital unchanged, the gross marginal physical product of the services of capital will be greater. The lower price level will be associated with a lower rate of return on money balances and a higher rate of return on capital. The lower price level cannot, then, be consistent with portfolio balance temporary equilibrium.Google Scholar
  13. 13.
    The lower price level, by seemingly making the representative individual wealthier, may result in a change in the supply of labour and flow of saving, so that the equality of the two rates of return brought about by the equilibrating price level must also take into account such effects.Google Scholar
  14. 14.
    If there are different individuals with different preferences, then it is possible that there will be multiple temporary equilibrium price levels.Google Scholar
  15. 15.
    If one doubled M, all that would occur would be a doubling of the price level, P, and, since m = Mt/[P2L0e(n+n′) t], nothing ‘real’ would follow. This result is based on the temporary equilibrium line of reasoning set out above so that if history dictates a particular k and M, temporary equilibrium entails a P such that portfolio equilibrium holds. Should history dictate a different nominal stock of fiat money, the initial temporary equilibrium would entail a proportionately different price level. The Authorities, considering once-over changes in the nominal money supply, will not do so in an unexpected or surprising fashion. I assume that the community, having seen its Monetary Arrangements evolve to the point where the real resources involved in the production and maintaintence of those Arrangements are at a minimum, will not countenance Authorities, supposedly the caretakers of such Arrangements, behaving in unpredictable, random and idiosyncratic fashions nor will the Authorities, in the confines of this model, be deemed to be behaving in a manner inconsistent with the underlying monetary theory. I do not consider at this stage, then, the Authorities acting in a discretionary way.Google Scholar
  16. 16.
    For a discussion of the welfare losses associated with inflation, see Martin J. Bailey, ‘Welfare Cost of Inflationary finance’, Journal of Political Economy, 64 (April 1956) pp. 93–110; Milton Friedman, ‘The Optimum Quantity of Money’, in The Optimum Quantity of Money and Other Essays (Chicago: Aldine-Alberton, 1969); and three papers by Harry Johnson, ‘Problems of Efficiency in Monetary Management’, ‘Inside Money, Outside Money, Income, Wealth and Welfare in Monetary Theory’, and ‘Is There an Optimum Money Supply?’ in his Further Essays in Monetary Economics (London: George Allen & Unwin, 1972).CrossRefGoogle Scholar
  17. 17.
    It is the difficulty of paying interest on circulating bank notes and coin that leads to the adoption of a deflation monetary growth rule as the device for ‘paying’ a real rate of interest on money balances. Interest can be paid on bank notes but it probably would be too costly to pay interest on circulating coin. See Harry G. Johnson, Further Essays. It will be remembered that I am not discussing Weldon’s point about the impossibility of such supernonneutral monetary policy.Google Scholar
  18. 18.
    The reader will note that I have not said that the payment of the steady state net rate of return in the form of the real rate of interest on money balances will be an optimum monetary policy all along the sequence of temporary equilibria.Google Scholar
  19. 19.
    See Bailey’s comment in Weldon, 1971, in which he makes the point ‘that one needs a general rather than a partial equilibrium demand’ schedule for the services of real money balances to measure the Bailey trapezoids. In the simple general equilibrium model I set out, adoption of the optimum money supply rule leads to greater capital and real money balance intensities in the steady state. One could introduce Sidrauski results so that only real money balances would be greater, or Tobin results so that, though total wealth would be greater, the greater real money balances would be accompanied by reduced capital intensity. Cambridge capital theoretic results might entail that, in the steady state with the optimum money supply policy in force, it could be that real capital intensities might be sufficiently lower so that overall wealth would also be lower, suggesting very damaging ambiguity with respect to the optimum rule. (See David Laidler, ‘Notes for a Panel Discussion on the Relevance of the Work of the Stockholm School for Modern Economics’, mimeo, n. d.) Laidler argues that adoption of the monetary rule alters the real rate of interest and relative prices setting in motion the whole problem of capital aggregation. It should be noted, however, that what is altered is the real rate of interest on money balances and not the steady state real rate of return to capital. It is changes in the monetary and capital intensities which take place owing to change in the real rate of interest on money balances which requires investigation. I have not explored the possibilities of ‘perverse’ changes in such intensities in this chapter.Google Scholar
  20. 20.
    See D. H. Robertson, ‘Utility and All That’, Utility and All That and Other Essays (London: George Allen & Unwin, 1952).Google Scholar
  21. 21.
    Some argue that the inflation tax is not necessarily nonoptimal. See E. Phelps, ‘Inflation in the Theory of Public Finance’, Swedish Journal of Economics, 75 (March 1973) pp. 67–82, and A. Drazen, ‘The Optimal Rate of Inflation Revisited’, Journal of Monetary Economics, 5 (1979) pp. 231–48.CrossRefGoogle Scholar
  22. 22.
    See M. Feldstein, ‘The Welfare Cost of Permanent Inflation and Optimal Short Run Economic Policy’, Journal of Political Economy, 56 (August 1979) pp. 745–68; Finn E. Kydland and Edward C. Prescott, ‘Rules Rather than Discretion: The Inconsistency of Optimal Plans’, Journal of Political Economy, 85 (June 1977) pp. 473–91; R. J. Barro, ‘Recent Developments in the Theory of Rules versus Discretion’, Economic Journal, 96, Conference Papers 1986, pp. 23–37; and Nicholas Rowe, Rules and Institutions (Deddington, Oxford: Philip Allan, 1989).Google Scholar
  23. 23.
    In an addendum to his 1971 paper, Weldon refers (p. 163) to a remark by Professor Kaliski of Queen’s University that a ‘private valuation of an extra ’phone misses the improved worth of all existing phones’, a point Weldon subsequently reiterated (Weldon, 1973; p. 22) and to which Laidler refers (Laidler, 1977, p. 333, and Laidler, 1988 and 1988a). The analogy between the service of a telephone and a bank deposit is apparently the reason for the externality associated with money, over and above that associated with the externality discussed by Friedman (Friedman, 1969) in discussing there the difference between the private and social marginal cost of acquiring extra ‘real’ money balances.Google Scholar
  24. 24.
    In the text, for instance, it was alleged that the Monetary Authorities could provide a clearing system more efficiently than could be privately provided. No rationale for the assumption was given. Indeed, the assumption is much questioned in the literature. See, for example, Richard H. Timberlake, Jr., The Origins of Central Banking in the United States (Cambridge, Mass.: Harvard University Press, 1978), and ‘The Central Banking Role of Clearinghouse Associations’, Journal of Money, Credit and Banking, 16 (February 1984) pp. 1–15.Google Scholar
  25. 25.
    See George Selgin, The Theory of Free Banking: Money supply under competitive note issue (Totowa, N. J., USA: Rowan Littlefield, 1988).Google Scholar
  26. 26.
    See Selgin, ibid.Google Scholar
  27. 27.
    See E. Fama, ‘Financial Intermediation and Price Level Control’, Journal of Monetary Economics, 12 (July 1983) pp. 1–28.CrossRefGoogle Scholar
  28. 28.
    See Harry G. Johnson, ‘A Note on the Dishonest Government and the Inflation Tax’, Journal of Monetary Economics, 3 (July 1977) pp. 375–77.CrossRefGoogle Scholar
  29. 29.
    If one assumes an initial capital stock which exceeds the steady state level, then the reader can understand Figure 6.3 by tracing out a process of ever lower prices and unstable capital and real money balance accumulation. One starts the analysis by showing that the initial temporary equilibrium price level entails that the equal rates of return to capital and real money balances exceed the steady rate of return.Google Scholar

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© Athanasios Asimakopulos, Robert D. Cairns and Christopher Green 1990

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  • Thomas K. Rymes

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