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Bank Deregulation and the Role of Medium of Account: A Critical Review, Study notes of Accounting

A critical review of recent publications by Black, Fama, Hall, Greenfield, and Yeager that advocate for bank deregulation and the possibility of an economy where most transactions are carried out through an accounting system rather than a tangible medium of exchange. The authors suggest that improved monetary performance could be induced by separating the unit of account from the medium of exchange. The document also discusses the implications of this idea and the challenges of enforcing the definition of the unit of account.

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NBER WORKING PAPER SERIES
BANK DEREGULATION, ACCOUNTING SYSTEMS OF
EXCHANGE, AND THE UNIT OF ACCOUNT:
A CRITICAL REVIEW
Bennett T. McCallum
Working Paper No. 15i2
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
March 1985
This paper was prepared for the Carnegie—Rochester Conference on
Public Policy, held in Pittsburgh on November 16—li, 198)4. I am
indebted to Allan Meltzer and Marvin Goodfriend for many helpful
discussions on the topics of concern and to Robert Barro, Robert
Greenfield, Robert Hall, Edward Shaw, Lawrence White and Leland
Yeager for helpful comments. Financial support by the National
Science Foundation (SES 8)4—08691) is gratefully acknowledged. The
research reported here is part of the NBER's research program in
Financial Markets and Monetary Economics. Any opinions expressed
are those of the author and not those of the National Bureau of
Economic Research.
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Download Bank Deregulation and the Role of Medium of Account: A Critical Review and more Study notes Accounting in PDF only on Docsity!

NBER WORKING PAPER SERIES

BANK DEREGULATION, ACCOUNTING SYSTEMS OF EXCHANGE, A CRITICALAND THE UNIT REVIEW OF ACCOUNT:

Bennett T. McCallum

Working Paper No. 15i

NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 March 1985

This paper was prepared for the Carnegie—Rochester Conference on Public Policy, held in Pittsburgh on November 16—li, 198)4. I^ am discussionsindebted^ to onAllan the^ Meltzertopics ofand concern^ Marvin andGoodfriend to Robert^ for Barro,^ many^ helpfulRobert Greenfield, Robert Hall, Edward Shaw, Lawrence White and Leland Yeager for helpful comments. Financial support by the National Scienceresearch Foundation reported here(SES is8)4—08691) part of theis gratefullyNBER's research acknowledged. program inThe Financial are those ofMarkets the author and Monetary and not Economics.those of the Any National opinions Bureau expressed of Economic Research.

NBER March Working 1985 Paper #

BankDeregulation,AccountingSystemsofExchange,andtheUnitof Account:ACriticalReview ABSTRACT

ThispaperreviewsaspecificgroupofrecentpublicationsbyBlack,Fama,Hall,and GreenfieldandYeagerthat(i)encouragetherelaxationofgovernmentcontrolsonthebanking industry,(ii)emphasizethepossibilityofaneconomyinwhichmosttransactionsarecarried outthroughanaccountingsystemratherthananytangiblemedium of (^) exchange,and(iii)

suggestthatimprovedmonetary performance couldbeinducedbyseparatingtheunitof

accountfromthemediumofexchange. Themainsubstantiveconclusionsareasfollows. First,asystemwithanunregulatedbankingsectorandagovernment—issuedcurrencywouldbe viableandmightreduceinefficienciesresultingfromreserverequirements,apointthathas beenrecognizedbyneoclassical monetary economists. The second mainclassofsystems discussedinthereviewedpapers——onewithacomposite—commoditymediumofaccountandno convertibilityprovision——isquitedifferent.Iftherewereliterallynomediumofexchange,the non—coercivegovernmentdesignationoftheunitofaccountwouldencounternoinconsistency butwouldbeextremelyfragile.Morerealistically,withsomecirculating private currency the latter (^) wouldtendtobecomethemediumofaccountaswellasthemediumofexchangeand wouldtendtobeissuedinexcess,therebyseparatingtheunitofaccountfromtheofficially— designatedbundleofcommodities. (^) Severalconclusionsregardinganalyticalapproacharealso developed. BennettT. McCallum GraduateSchoolofIndustrialAdministration Carnegie—Mellon Pittsburgh,University PA 15213 (412) 578—

theleadingmonetarists(i.e.,Friedman,Brunner,Meltzer)havelongbeenregardedbymuchof theprofessionaslaissezfaireextremists.Infact,accordingtoHall(1982b),theBFHschoolis stronglycriticalofsomeofthemostbasictenetsofmonetarism.Thus"thenewmonetary economicsviewsthequantitytheoryasnothingmorethananartifactofgovernmentregulation" (Hall1982b,p.1552)while"themoneystockitselfisacreatureofinefficientregulation"(p. 1555).Black(1970)voicessomesimilarlyanti—monetaristsuggestions,suchasthefollowing: "Assoonaswegettoaworldwherepaymentsaremadebytransferringdepositsandnotes, thequantitytheorybecomesimpossibleeventoformulate"(1970,p.19). AndevenFama,

whosepositionislessradical,expressesratherstronglysomeviewsthatappearhardto

reconcilewithmonetaristtraditions. Oneexampleisprovidedbyhissuggestionthat"the bankingsystemisbestunderstoodwithoutthemischiefintroducedbytheconceptofmoney" (1980,p.44)2 One objectofmydiscussion,accordingly,willbetoconsidertheextentto whichdisagreementbetweentheBFHschoolandmonetaristsislogicallyimpliedbydifferent

theoreticaland/orempiricalbeliefs,andtheextenttowhichitisinsteadtheresultof

misinterpretationoftheothergroup'sposition.

Briefmentionshouldbemadeattheoutsetoftwopreviouspapersthatprovidecritical

considerationoftheliteratureinquestion. ThefirstoftheseisFischer's(1983)useful

presentationofhisown"FrameworkforMonetaryandBankingAnalysis,"whichtouchesupon

severalofthetopicsconsideredbelow. ThereisverylittleattemptinFischer'spaperto

commentspecificallyuponclaimsoftheBFHschool,however,andsomeofitsdistinctive propositionsarenotcarefullyexamined.3Thesecondofthesepapersisaveryrecentarticleby White(1984),whichisexplicitlyconcernedwiththeBFHliteraturebutmainlywithregardtoa singleissue,viz.,thepossibilityofadivorceoftheunitofaccountandmediumofexchange. White'streatment,moreover,ismorehistoricalinemphasisthantheonedevelopedbelow.It thusprovidesausefulcomplement,whichIshalldrawuponinafewplaces.

Itshouldalsobementionedthat,intheirattitudetowardderegulation,theBFHwritings displayanotableelementofsimilaritywiththe"competitivecurrencies"proposalsofKlein

(1974),Saving(1976),Hayek(1978),Vaubel(1978),andothers.Thereis,however,amoderately cleardistinctionbetweenthetwogroupsprovidedbytheBFHemphasisonaccounting(as opposedtomonetary)exchangeandbythefloating—rateaspectofthevariouscurrenciesinthe othergroup;foranelaborationonthesedifferencesthereaderisreferredtoYeager(1983). Thepresentpaperdoesnotattempttosurveyoranalyzethecompetitivecurrenciesliterature.

wherebytheunitofaccount(e.g.,dollarsorounces)isaspecifiedquantityoftheassetthat servesasthemediumofaccount(e.g.,FederalReservenotesorgold).6Anobviousalternative istousethetermnumerairetorefertotheasset,someunitofwhichservesastheunitof account.7Thistermissometimesutilized,however,torefertothegoodthatisthebasisfor relativepricesasexpressedbytheeconomicanalyst,notasthebasisforpricesasstatedby sellersintheeconomyitself.8Inordertobedefinitewithrespecttothisdistinction,Iwilluse Niehans'terminwhatfollows: themediumofaccountisagood(orcollectionofgoods) someunitofwhichisusedasthebaseforpricesquotedbysellersintheeconomyunder study.

Theforegoingdiscussionprovidesareminderthatthereisnologicalnecessityforan economy'smediumofaccount(MOA)anditsmediumofexchange(MOE)tobethesame. Oncethatisrecognizeditmustbeadmittedthat,asFischer(1983,p.8)hasremarked,thereis nothinginmostmonetaryanalysesbearingonthedeterminationoftheidentityoftheMOA. Buthavingadmittedthat,itisimportantalsotorecognizethatinamonetaryeconomythe benefitsofhavingacommonunitofaccountareincompleteunlesstheMOAisalsotheMOE. Thispoint,whichismadeexplicitlybyNiehans(1978,p.121),maybeputintheformofa substantiveproposition:unlessprovidedwithinducementstodootherwise,sellerswillquote pricesintermsofthemediumofexchange;theMOAandMOEtendtocoincide. The validityofthispropositionisstronglysupportedbytheevolutionaryandhistoricalanalysis

presentedbyWhite(1984). Thepropositiondoesnotdeny,ofcourse,thattherecanbe

inducements——suchasthepresenceofsubstantialinflationintermsoftheMOE——foragentsto makecontractsintermsofsomethingotherthantheMOE.

III.Fama

LetusnowbeginwithadiscussionofFama(1980),whichhasbeendescribedas"perhaps themostinfluentialstatementofthenewmonetaryeconomics."'°Fama'sanalysisinthispaper centersontwohypotheticaleconomies.Thefirstoftheseisoneinwhichthereisnotangible mediumofexchange. (^) Thereis,however,asophisticatedaccountingsystemofexchange (ASOE),accesstowhichisprovidedbydepositsheldwithbanks.1'Competitiveinterestrates arepaidbybanksondepositsandchargesaremadefortransactionservicesprovidedto depositors. Depositsareheterogeneousinthesensethattheyareclaimstoportfolioshares, thecompositionofwhichmaybetailoredtothedesiresofindividualdepositors.Thusbanks provideasecondtypeofservice——portfoliomanagement.Theseservices,likethosepertaining totransactions,arepricedcompetitively.

AsthiseconomyincludesnoMOE,itisanonmonetaryeconomy. (^) Analysisofits

workingsintheabsenceofregulationthenbecomesastandardprobleminrealgeneral

equilibriumtheory'2Famausesthisinsighttoassistintheanalysisoftheeffectsof

government—imposedregulations,includingcontrolsondepositinterestratesandtherequirement thatbankshold(non—interest—bearing)reserves——fractionsoftheirassets——withthegovernment's "centralbank."Thisapproachmakesitclearthatamajoreffectofreserverequirementsis

simplytolevyataxonbanks,therebyloweringdepositreturnstodepositors. Asa

consequence,householdsandfirms"areinducedtoeconomizetheirholdingsofdepositsandso toincurreplenishmentandothercoststhatwouldbeunnecessaryintheabsenceofareserve requirement"(Fama1980,p.47).Thepresumptionwouldseemtobethatthisrestrictionis sociallyundesirable,aconclusionthatseemsreasonablyconvincingforthisnonmonetary economy.13Somewhatsimilarconsiderationspertaintodepositrateregulations.

FamausestheforegoingframeworktocriticizeargumentsmadebyJohnson(1968),Pesek

andSaving(1967),GurleyandShaw(1960),andPatinkin(1961). Thefirsttwoofthese

referencescontendthat,intheabsenceofreserverequirements,depositraterestrictions,and otherregulations,thepricelevelwill"spiralupward"withoutboundwhilethesecondpair

travelisofrealvalue,suchastepwillclearlycreateademandforUnitsandwilltendto

induceagentstoholdfewerspaceships,justasFamasays.Anditmaycreateataxation

opportunityforthegovernment. ButthisdoesnotimplythattheUnitwillbecomethe

economy'sunitofaccount;creatingademandforUnitsisanecessarybutnotsufficient condition. Indeed,thereisnoevidentreasonwhysteelshouldnotremainthemedium(and Ingotstheunit)ofaccount.Itwouldappearthatthefunctionofreserverequirementsthatis pointedoutbythespaceshipexampleistocreateademandforanintrinsicallyworthlessentity issuedandcontrolledbythegovernment,nottodictatetheunitofaccount.

Letusnowturntothesecondhypotheticaleconomy,orclassofeconomies,discussedby Fama.Inthiscasecompetitivebanksprovideportfoliomanagementandtransactionservicesas beforebutnowtherealsoexistsatangiblemediumofexchange,namely,government—issued

papercurrency. Thelatterprovidesitsholderswithtransactionservicesthatare(by

assumption)imperfectlysubstitutableforthoseofferedbytheASOE.Furthermore,currencyis suppliedmonopolisticallybythegovernment,butbanksvoluntarilyholdstockslargeenoughto permitthemtomaintainconvertibilitybetweendepositsandcurrency.

Inthismonetaryeconomyitisreasonabletoassumethatcurrencywillserveasthe mediumofaccount,inaccordancewiththepropositiondescribedinourSectionII,andFama makesthisassumption.Healsopresumesthatcurrencyhasafixedownrateofinterestof zeroandthatthegovernmentcontrolsthesizeofthenominalstockofcurrency.Thuswitha well—defineddemandforcurrencyinrealterms(resultingfromitsservices)andwithafixed nominalstock,itsnominalvalue——andthusthepricelevel——iswelldetermined.Underthese circumstances,thereisnomotivationforunregulatedbankstotakeactionsthatwoulddrive thepricelevelupward.

Furthermore,wehaveseenabovethatthegovernmentcancreateademandfor

intrinsicallyuselessandnon—interest—bearing"reserves"thatitissues,eitheraspiecesofpaper orasbookkeepingentries.Soitcouldimposereserverequirementsonbanks,inthepresent

economy,requiringthemtoholdreservesinsomespecifiedrelationtobankdeposits. Ifthat

stepweretaken,thegovernmentcouldthenmaintaindeterminacyofthepricelevelwithout explicitconcernforthequantityofcurrencyinexistenceifitcontrolledthesupplyofreserves innominal(unitofaccount)terms. Sincedepositsarevaluable,andreservesarerequiredfor theexistenceofdeposits,arealdemandforreserveswillexistandspecificationofthenominal quantitybythegovernmentwillpindownthepriceofreserves.

Inwhatunitswillthesepriceshequoted?AccordingtothepropositionofSectionII above,currencywouldtendtoremaintheeconomy'smediumofaccountandsomecurrency unitwouldthenbetheunitofaccount.Reservesmightbedenominatedinunitsthathavea fixedvalueintermsofcurrency,butsuchwouldnotbenecessary.Providedthatamarketin reservesisnotprohibited,thepricelevelintermsofcurrencycanberegulatedviathesupply ofreservesevenwiththelatter'svaluepotentiallyvariableincurrencyterms.

DoestheanalysisinthismodelofFama'sprovideavalidbasisforcriticismofFriedman, Johnson,GurleyandShaw,PesekandSaving,orPatinkin?Theanswerwouldseemagainto be"no"inthecaseofFriedmanandGurley/Shaw,forbotharediscussingmonetaryeconomies inwhichthereisnooutsidecurrency(orreserves)forthegovernmenttocontrolinnominal

terms. And,ashisreaderswillknow,Famaexplicitlyagreesthathisviewpointis

fundamentallyconsistentwithPatinkin's.15Johnson,however,iscriticizedbyFamaforhis statementthatpricelevelstability"requiressocialcontroloverthetotalquantityofmoney suppliedbythebankingsystem"(Johnson,1968,p.43). InFama'sview,"theconfusionin Johnson'sinterpretationofPatinkinprobablyarisesfromthefactthatPatinkin... treats depositsasmoney,"i.e.,doesnotdistinguishbetweendepositsandcurrency. Inmyopinion, Fama'sinsistencethatcurrencyanddepositsbeviewedasdistinctentitiesisuseful;toreferto "money"asthe"product"offeredbybanksismorelikelytoleadtoanalyticalerrorthanto viewbanksassellingtwo(ormore)typesofservices.ButwhileJohnson'sterminologyisin thisregardconfusing,Johnsondoesmanagetoconclude——aswouldFama——that"thecentral bankcancontrolthepricelevelifitfixestheyieldonitsliabilitiesandcontrolsthequantity

IV.Black ThetwoanalyticalmodelsusedbyFamaareinmostrespectssimilartoonesdevelopedin amuchearlierarticlebyFischerBlack(1970). (^) Inthispiece,Blackdescribesanumberof hypotheticaleconomies,someofwhicharefreeoffinancialregulationsandallofwhich incorporateanASOE(togetherwithorinsteadofatangibleMOE).Indeed,manyofthe

distinctiveinsightsandviewpointsoftheBFHschoolcanbeclearlytracedtoBlack's

pioneeringpaper.Thelatteralsofeatures,however,alargenumberofassertionsconcerning theunimportanceorvaguenessofthequantityofmoneyandthepointlessnessofthequantity theory.Theseassertionsare,inmyopinion,unhelpfulatbestandservetodetractfromthe overallmeritofBlack'scontribution.Inthefollowingparagraphs,afewexamplesofthistype willbedescribed.

Black'smaindiscussionpertainstoaneconomyinwhichalltransactionsarecarriedout bymeansofanASOEor,almostequivalently,bycheckswrittenonbankdepositsthatare claimstoportionsofthebank'sportfolioofassets. Thereexists,byassumption,notangible mediumofexchangeineithercase.Thereis,therefore,littleanalyticalenlightenmentprovided bytheobservationthat"thereisnothinginthis... world thatcanmeaningfullybecalleda quantityofmoney"(1970,p.10). Inotherwords,whilethisassertioniscorrectitdoesnot implythatanyformofvaguenessappliestotheconceptofthequantityofmoney.Onthe contraryitispossibletosayquitepreciselywhatthemagnitudeofthemoneystockis,inthis hypotheticaleconomy:itiszero.

ElsewhereatBlack'sbehestwe"takeonestepinthedirectionofamorecomplexworld byintroducingcurrency.Thefederalgovernmentwillprintthecurrency,andwillissueitto banksasrequested"(p.13)whichwillpassitontoindividualsasrequested,withappropriate creditsanddebitsenteredtoaccountswiththerelevantbanks."Thustheamountofcurrency heldbyindividualsandbusinesseswillbedeterminedbyhowmuchisneededforsmall payments.Solongastheinterestrateonbankaccountsispositive,anindividualwillwantto holddowntheamountofcurrencythathecarries.becausecurrencyearnsnointerest"(p.13).

Allofthissoundsresonablystandard.ButthenBlackindicatesthattherewillbenoneedfor

anyfederalagencytofixtheamountofcurrencyoutstanding"(p.14)andconcludesas

follows:

Currencyalonecanhardlypassforthewholeofmoney. Thequantityof

currency,inthisworld,willnotbecontrolledbythecentralbank,andwillnot

influencetheeconomy.Soevenwhencurrencyisaddedtoourmodel,thequantity ofmoneycanhavenoeffectonoutput,employment,orprices,becausethequantity ofmoneydoesnotexist"(1970,p.14).

Butthisconclusionseems,tome,quiteunjustified. ThereisatangibleMOEinthis

hypotheticaleconomy,i.e.,currency,andthestockofmoneyisappropriatelymeasuredasthe quantityofcurrency.ItisunclearwhyBlackbelievesthismeasuretobeunsatisfactory. Isit becausethegovernmentdoesnot(byassumption)choosetocontrolitsquantity?Orbecause thereareotherpaperassetsinexistence?Orbecausethereareways,notinvolvingcurrency, ofeffectingtransactions? Butnoneofthesepotentialreasonsseemsvalid;noneofthem underminesthepossibilityofmeasuringthequantityofthemediumofexchange——whichinthis caseissimplycurrency.

Apossibleobjectiontomyconclusion,thatcurrencycomprisestheentiremoneystockin thecurrentexample,isthateconomistswhoemploytheMOEdefinitiontypicallyinclude checkabledeposits(aswellasFederalReservenotes)intheirempiricalmeasureoftheU.S. moneystock.Butthereisacompellingreasonforthat,namely,thatU.S.institutionsaresuch thatcheckabledepositsareclaimstocurrency,claimsthatcanbeexecutedwithoutdelayor significantfinancialpenalty. Thatfactsuggeststhatdemanddepositsshouldbetreatedas nearlyperfectsubstitutesforcurrencyfromthestandpointofthenonbankpublic. Itmaybe

usefulforsomepurposes,therefore,toviewthesumofthesetwoitemsastheexisting

quantityofthemediumofexchange,eventhoughpaymentsbycheckactuallyinvolvetransfers ofclaimstocurrencyratherthantransfersofcurrencyitself.

Thereare,ofcourse,seriousproblemsthatariseinanyattempttoimplementthisconcept empirically.Aleadingdifficultyatthepresentpointoftime(i.e.,1984)wouldbetodecide whichactualaccountsare,andwhicharenot,checkable. Butananalogousproblemwould

interestitwouldneedtobethecasethatactualeconomieswillsoonexistwhichpossessno mediumofexchange. (^) Furthermore,themainmessageofthequantitytheory——namely,that

exogenouschangesinthequantityofspecifiedpaperassetswillhavenoultimateeffectonthe economy'slevelofrealoutput——wouldappeartoremainvalideveninthissetting.

V.Hall ThecontributionbyHall(1982a)continuestopromotebankingderegulationbutaddsa newingredientbyturninginthedirectionofacommoditymoneystandard. Inthisregard, Hall'sproposalpossessesanimportantsimilaritytothe"commodity—reservecurrency"scheme—— itselfageneralizationofAlfredMarshall's(1887)"symmetallism"——thatwasexhaustively

analyzedbyFriedman(1951). Thepresenceorabsenceofatangiblemediumofexchangeis notexplicitlyconsideredbyHall,butatleastonepassage(onp.120)seemsclearlytoimply thattheexistenceofsuchamediumistakenforgranted.Inanyevent,Hallproposesthat theunitofaccountbedefinedasacommoditybundleincludingspecifiedquantitiesofseveral goods,selectedsothattheexchangevalueofthebundlewilltendtoconformmorecloselyto thegeneral"costofliving"thanwouldbethecasewithanysinglemonetarycommoditysuch asgold.Theobjectistopreventbothtrendsandfluctuationsinthepricelevel——thecostof livingintermsoftheunitofaccount——which,itispresumed,areinimicaltothewelfareof theeconomy'sindividuals.

Therearetwoimportantways,however,inwhichthisproposalofHall's——evenwhen interpretedasincludingatangibleMOE——differssignificantlyfromthecommodityreserve

schemediscussedbyFriedman. Thefirstoftheseinvolves"gradualadjustmentsinthe

definitionofthedollar[i.e.,theunitofaccount]sothatitspurchasingpowerremains

constantastimepasses"(Hall,1982a,p.115).Withoutsometypeofadjustmenttherewould bepricelevelchangesovertimeevenwithacomposite—commoditybundlesuchasHall's ANCAP,23soHallproposesthatthedefinition(thescale.notcomposition)ofthestandard bundlebeadjustedinresponsetodeparturesofthepricelevelfroma(constant)targetvalue. Thisfeature,whichisbasedonanideadevelopedbyIrvingFisher(1913),contrastssharply withtheusualcommodity—standardprinciplewherebythedefinitionofthestandardbundleis fixed,supposedlyforeternity.

Isthisadjustable—bundlefeatureofHall'sproposaldesirable?Onepossibleobjectionthat somemightraisewouldcharacterizeitasinjecting"tinkering"ordiscretionarybehaviorintoa

opportunitiesforcoveredarbitrage"(p.118). Butunderwhatconditionsisittruethat

arbitrageopportunitieswouldexist? Itiscertainlyclearthatsuchopportunitieswouldbe availableifthegovernmentwascommittedtomaintainconvertibility,bystandingreadyto exchangepaperdollarsandstandardbundlesoneforone.Butgovernmentinterventionofthis typehasbeenruledout.Anotherpossibilityisthatbanks26wouldmaintainconvertibility——but thatdutywouldhavetobeundertakenvoluntarily,sinceagovernmentalrequirementtothat effectwouldbeinconsistentwiththerecommendedabsenceofregulation.Hall'sview,inany event,seemstobethatconvertibilitycommitmentswouldbeunnecessary;thatthearbitrage opportunitieswouldbecreatedbythelegaltenderprovisionitself.27Butthathypothesisseems tomeunconvincing.Whatismeantbyalegaltenderprovisionisthatthecourtswillnot helpacreditortocollectadebtifthecreditorhasrefusedpaymentofferedbyadebtorinan assetthathaslegaltenderstatus.28Theusualpurposeofsuchalawistoconferacceptability onasecondaryclassofassets,bydenyingcreditorshelpiftheyrejectsuchassetsandtryto requirepaymentinapreferred(andsimilarly—denominated)primarymoney. Inparticular, legaltenderlawsdonotrequirethatallcontractsbespecifiedintermsoflegal—tenderassets. Thus,evenifstandardbundlesarethesolelegaltenderassetinHall'seconomy,itwouldbe possibleforbuyersandsellersroutinelytousepaperdollarsastheMOEandapaperdollaras theunitofaccount. Consequently,itwouldbepossibleforthepaperdollarpriceofa standardbundletodifferfrom1.0,withoutcreatinganyarbitrageopportunity,ifnooneis committedtothemaintenanceofconvertibility.Indeed,thepaperdollarpriceofthestandard

bundlewillvarydirectlywiththenumberofpaperdollarsinexistence;thefunctionof

convertibilityistoforcethequantityoftheMOEtobesuchastomaintaintheprice

standard.

Thealternativeideaherebeingpursuedisthatpaperdollarsmight,underHall'sscheme, gainacceptanceastheMOEbyinitiallyexistingasclaimstostandardbundles——claims redeemablebybanksthatvoluntarilymaintainconvertibility. Butthen,sinceitiscostlyto maintaintherequisitecommodityreservesandsincetheconvertibilityoptionisveryrarely exercised,banksmighteventuallydoawaywiththisguarantee.Thepaperdollarwouldthen

becomeaninconvertiblepaperasset,withoutlegaltenderstatus,thatneverthelessfunctionedas theMOE——justaswasthecasewithBankofEnglandnotesbetween1797and1821.°The paperdollarwouldhavevalue,ifthistranspired,becauseofitsMOEserviceflow,notbecause itwasaclaimtoastandardbundle.Undersuchcircumstances,itisclearthatitsvaluecould departfromthatofastandardbundle——justasthevalueofBankofEnglandnotesdeparted fromthatoftheirnominalgoldbullionequivalentintheearly1800's.

Hall's(1982a)argumentagainstthissuggestionisthat"itisimpossible"forthedescribed situationtoarisebecause"whensellerspostadollarprice,theyhavetherighttoreceive paymentinresourceunits[i.e.,standardbundles]insteadofanyotherformofpayment"(p. 118). Butthatargumentpresumesthatbuyersandsellersaremakingexchangesinwhichthere isambiguityastowhetherthe"dollarprice"referstopaperdollarsorstandardbundles. Rationalagentswouldnot,however,engageinexchangesinwhichsomuchambiguityprevailed. Inatemporaltransactions,bothpartieswould(underthealternativescenario)takeitfor grantedthatpostedpricesrefertopaper—dollarmagnitudes.31Loancontractsextendingover timewouldbeadifferentmatter,becauseofthelegaltendersituation,andspecificprovisions wouldhavetobemadeiftheseweretobespecifiedinpaperdollars. Butsuchprovisions couldberoutinelyaddedatalmostnocost. (^) Bankaccounts,finally,wouldbe——underthe presenthypothesis——denominatedinpaperdollarsratherthanstandardbundles.

ThelatterconsiderationindicatesthatHall'soutcomecouldprobablybeattainedbya law——moresweepingthanalegaltenderlaw——declaringthatnoloancontractswouldbe enforcedunlessspecifiedintermsofstandard—bundledollars.Thiswouldnecessitatethatbank accountsbedenominatedinthesedollars,andthatwouldprobablyresultinthepaperMOE consistingofclaimstostandardbundles. (^) Thissortofalawwould,ofcourse,constitutea seriouslimitationonthetypesofcontractsthatwouldbeviable.

Whattheforegoinglineofargumentsuggestsisthatifaneconomyhasapapermedium

ofexchange,thatpaperwillalsotendtoserveasthemediumofaccountevenifthe