Synthesizing State and Spontaneous Order Theories of Money

February, 2014

What role does government play in determining the medium of exchange? Economists weighing in on the issue have typically espoused one of two views. State theorists credit government with the emergence and continued acceptance of commonly accepted media of exchange. In contrast, spontaneous order theorists find little need for government, maintaining that money emerges and continues to circulate as a result of a decentralized market process. History suggests a more subtle theory is required. We provide a generalized theory of the emergence and perpetuation of money, informed by both approaches and consistent with recent theoretical and empirical advances in the literature.

Banning Bitcoin

October, 2017

We employ a monetary model with endogenous search and random consumption preferences to consider the extent to which a government can ban an alternative currency, like bitcoin. We define a ban as a policy whereby government agents refuse to accept an alternative currency and mete out punishments to private agents caught using it. After identifying monetary equilibria where an alternative currency is accepted, we then derive the conditions under which a ban might deter its use. As in earlier studies, we show that a government of sufficient size can prevent an alternative currency from circulating without relying on punishments. We also show that, given its size, a government can ban an alternative currency so long as it is willing and able to mete out sufficiently severe punishments.

Alexander Salter and William Luther Interviewed on Free To Exchange

Are financial regulations helping protect us after the financial crisis? Can currencies like Bitcoin protect individual liberty? Mercatus PhD alums Alexander Salter and William Luther discuss on this episode of Free to Exchange.

The Free Market Institute (FMI), in conjunction with KTTZ-TV, produces Free to Exchange, an interview-based television program that focuses on both historical and contemporary economic and public policy issues.

Monday, May 1, 2017
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Positively Valued Fiat Money after the Sovereign Disappears

January, 2017

The case of the Somali shilling defies the historical view that sovereign powers (i.e., legal tender status, public receivability) are necessary to explain the acceptance of fiat money at a positive value. Following the Somali state’s collapse in 1991, irredeemable paper shillings have continued to circulate at a positive value. Acceptance under statelessness is explained by a history that made continued acceptance a focal point among self-fulfilling strategies. Our explanation is consistent with an extended Kiyotaki-Wright model of fiat money. Although sovereign power may be necessary to launch a fiat money in practice, we maintain that it is not necessary for its survival.

The Political Economy of Bitcoin

November, 2015

The recent proliferation of bitcoin has been a boon for users but might pose problems for governments. Indeed, some governments have already taken steps to ban or discourage the use of bitcoin. In a model with endogenous matching and random consumption preferences, we find multiple monetary equilibria including one in which bitcoin coexists with official currency. We then identify the conditions under which government transactions policy might deter the use of bitcoin. We show that such a policy becomes more difficult if some users strictly prefer bitcoin because they can avoid other users holding the official currency in the matching process.

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The Implicit Costs of Government Deposit Insurance

June, 2016

Most people believe that the benefits of deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC) clearly exceed the costs. However, a growing literature suggests that the benefits of FDIC insurance are overstated while the costs are understated. We add to this literature by considering the implicit costs of government-provided deposit insurance. Specifically, we consider the costs arising from (1) an implicit taxpayer backstop and (2) suboptimal pricing. The implicit costs of government-provided deposit insurance are real economic costs borne by taxpayers, borrowers, lenders, and counterparties. Since such costs are routinely omitted from traditional cost-benefit analysis, most studies of the FDIC tend to be biased in favor of government-provided deposit insurance. 

On the Empirical Relevance of the Mises-Hayek Theory of the Trade Cycle

May, 2016

Lester and Wolff (2013) find little empirical support for the Austrian business cycle theory. According to their analysis, an unexpected monetary shock does not alter the structure of production in a way consistent with the Austrian view. Rather than increasing production in early and late stages relative to middle stages, they find the opposite--a positive monetary shock typically decreses production in early and late stages relative to middle stages. We argue that the measures of production and prices employed by Lester and Wolff (2013) are constructed in such a way that makes them inappropriate for assessing the empirical relevance of the Austrian business cycle theory's unique features. After describing how these measures are constructed and why using ratios of stages is problematic, we use a structural vector autoregression to consider the effects of a monetary shock on each stage of the production process. We show that, with a clearer understanding of what is actually being measured by the stage of process data, the results are consistent with (but not exclusive to) the Austrian view.

The Optimal Austrian Business Cycle Theory

May, 2016

Since Hayek's pioneering work in the 1930s, the Austrian business cycle theory (ABCT) has been presented as a disequilibrium theory populated by less-than-perfectly rational agents. In contrast, we maintain that (1) the Austrian business cycle theory is consistent with rational expectations and (2) the post-boom adjustment process can be understood in an equilibrium framework. Hence, we offer a new interpretation of the existing theory. In doing so, we also address concerns raised with Garrison's (2001) diagrammatic approach, wherein the economy moves beyond the production possibilities frontier. Our interpretation might accurately be described as a monetary disequilibrium approach grounded in an implicit general equilibrium framework with positive costs of reallocation.

Mises and the Moderns on the Inessentiality of Money in Equilibrium

March, 2016

The challenge of rendering monetary exchange intelligible within a Walrasian general equilibrium framework is well known. Perhaps less well known is the difficulty of integrating monetary and exchange economies in decentralized conceptions of equilibrium, of which the evenly rotating economy of Ludwig von Mises (1949) is an early example. After reviewing the prospect for money in the evenly rotating economy, I survey the modern literature on frictions that make money useful for exchange. While exploring techniques commonly used to generate a useful role for money in this environment, I make a distinction between exchange frictions and epistemic frictions. Although theoretical efforts have largely focused on exchange frictions, recent experimental evidence suggests that epistemic frictions warrant further attention. I conclude that Mises should be seen as a pioneer in this literature, though recent advances demonstrate that the set of frictions capable of rendering money useful is much larger than he envisioned.

Bitcoin and the Future of Digital Payments

January, 2016

To become widely adopted, bitcoin and other alt-coins must overcome competition from existing, government-sponsored currencies and reduce the costs for consumers to switch to new payment systems. Until these challenges are met, digital currencies will therefore likely persist only as niche monies or substitutes for very weak currencies.

Find the article at the Independent Institute.