Notes
Chapter 1
1.For an extended version of this discussion of monetary systems, see Gerdes (1997).
2.It is erroneous to assert, as some economists do, that fiat money has no intrinsic value. From this perspective, the marginal subjective value of fiat money, when used for nonmonetary purposes, is zero. We know that is not the case. Examples of possible value generating nonmonetary uses for fiat money are using stacks of fiat money as doorstops, paperweights, or as kindling in the fireplace.
3.Had consumers preferred fiat money, issuers of fiduciary money would have voluntarily accommodated those preferences.
4.Some make the case that the U.S. government did not leave the gold standard until August 15, 1971. On that date, President Richard Nixon closed the U.S. gold window to all foreign central banks. From 1933 to 1971, gold had a very limited monetary role. Governments allowed central banks to settle imbalances of payments through gold shipments. It is difficult, however, to make the case that the United States was on the gold standard from 1933 to 1971 when it was illegal for all households and private businesses in the United States to possess any monetary gold.
5.Deflation is also self-limiting with fiduciary money. Market forces tend to increase the quantity of commodity money. If a government reduces the quantity of fiduciary money to offset this, the ratio of fiduciary money to commodity falls. The lower limit for this ratio is zero. When the ratio approaches zero, the government is no longer able to offset the rising production of commodity money. Increases in the total quantity of money eventually bring to an end the deflation.
6.Traveler’s checks are demand deposits owned by bank customers but drawn on a commercial bank. Historically, they were used for making payment outside a country. Because individuals are now able to access funds in their checking accounts through ATM machines located in foreign countries, aggregate traveler’s checks have fallen to less than 1% of M1. Thus, these deposits are frequently disregarded in discussions of M1.
Chapter 2
1.The source for Fisher’s analysis is: Fisher, Irving, The Purchasing Power of Money [Fairfield, NJ: Augustus M. Kelley, 1913 (Reprinted 1985)].
2.Refer to Pigou (1917) for his version of the quantity theory of money.
3.One important distinction is that the Cambridge demand for money is a static concept. It typically applies to a given point in time. By contrast, Fisher’s velocity of circulation of money happens over a period of time.
4.Keynes (1936), p. 207.
5.Friedman and Schwartz (1963).
6.In an attempt to simplify Fisher’s macroeconomic analysis, some state that he assumed that velocity and real output are held constant. That is incorrect. For a discussion of this mischaracterization of Fisher’s analysis, see Gerdes (1986), pp. 66–72.
Chapter 3
1.An economic unit is a decision-making entity. These units are generally classified as a household, business, or governmental unit.
2.This method for classifying participation was employed by Van Horne (1998). It was also used in early flow-of-funds studies. See Goldsmith (1965).
3.Böhm-Bawerk (1959). This translation and compilation is from Böhm-Bawerk’s books on capital and interest written from 1884–1914. Chapter I in Book IV of Volume II is entitled “Present and Future in Economic Life.”
4.Böhm-Bawerk referred to this as contract or loan interest.
5.This analysis abstracts from other factors that might make for a positive price of credit even if individuals are indifferent between goods now and goods in the future. They would include transactions costs and risk. The issue of risk is discussed in some detail below.
6.von Mises (1949). A well-known student of von Mises, Murray Rothbard, defined interest in the same way. See Rothbard (1962).
7.Transactions costs, which are not discussed here, are also neglected. They, too, can affect the level of the real interest rate.
8.No risk premium is necessary if investors are generally risk-neutral or risk-preferred.
9.Yield curves with other shapes are also possible. Generally, they are a combination of those depicted in panels (a), (b), and (c). One such possibility is the humped yield curve. It initially rises, reaches a peak, and subsequently descends.
10.The following discussion of theories of the term structure draw from Van Horne (1998).
11.Irving Fisher is credited with an early version of this theory. See Fisher (1896), pp. 23–29 and pp. 91–92.
12.J. R. Hicks developed the liquidity preference argument. See Hicks (1946), pp. 145–147.
13.Modigliano and Sutch (1966), 178–97.
Chapter 4
1.The profit on this loan is not 5% because interest on this deposit is not the only cost to the bank. Additional costs are in the form of resources banks employ in servicing customer loan and deposit accounts.
2.Derivation of this equation appears in Appendix A at the end of this chapter.
3.The derivation of the M1-multiplier is found in Appendix B at the end of the chapter.
4.Until recently, banks in the United States earned no income on bank reserves. In 2008, the Federal Reserve began paying interest on reserves held at Federal Reserve Banks (MBD). The current annual rate for these deposits is 0.25%.
5.For a summary of these changes in discount rate policy, see Stevens (2003).
6.It is possible for Bank A to acquire additional reserves from other banks. In that case, Bank A will not have to contract its loan portfolio. However, the total quantity of reserves in the banking system has not changed. With a higher reserve requirement, this means that other banks in the system must contract their loan portfolios.
7.For a discussion of sweeps and their implications, see Anderson and Rasche (2001), pp. 51–72.
8.Exclusion from reserve requirements was an important feature of MMDA deposits, which were created in the Garn-St. Germain Act of 1982. However, there was an important qualification attached to this exclusion. No more than six withdrawals were allowed per month. If this qualification was not met, an MMDA deposit was treated as a transactions account (subject to reserve requirements applicable to those accounts).
9.The absence of an adequate financial infrastructure may result from the fact that these countries are poor. It may not. These countries may be poor because of a weak market structure. Their governments, in many cases, have actively discouraged the development of markets. It should come as no surprise that these countries cannot rely upon markets for the implementation of monetary policy.
Chapter 5
1.Banks, businesses, and individuals had three weeks to turn in their gold to the government. There were limited exceptions. Individuals could keep $100 in gold coins; coin collectors were allowed two specimens for any issue. So much gold was confiscated, that the U.S. government deemed it necessary to construct a large vault at Fort Knox, Kentucky. For a discussion of the U.S. nationalization of gold, refer to Weatherford (1997), chapter 12.
2.Had consumers preferred fiat money, issuers would have provided it volitionally As noted, absence of the convertibility option makes life easier for issuers of money.
3.Fischer (1996). England left the gold standard in 1931, and 20th century fiat money inflation is dated from that year.
4.This seigniorage curve is discussed in McCulloch (1982). He refers to it as a monetary Laffer curve, and notes that it was introduced by Martin Bailey long before the concept was employed by Arthur Laffer. See Bailey (1956).
5.To simplify the analysis, other influences on money demand (such as interest rates and income) are assumed to be fixed.
6.Other types of economic policy are available for use by governments. They include fiscal policy, exchange-rate policy, and wage and price controls. The focus here is on monetary policy.
Chapter 6
1.Weintraub (1978), pp. 341–362.
2.This is the rate of time preference for lenders. For a discussion, refer to Chapter 3, pp. 39–41.
3.In the early 1960s, and again in the recession of 2008–2009, the Federal Reserve introduced a program that employed the long-term nominal interest rate as the operating target. This procedure was dubbed operation twist because it attempted to twist the yield curve by lowering long-term interest rates. When the operating target is the long-term rate, the transmission mechanism does not navigate the yield curve. The current discussion of interest rate targeting abstracts from these special cases.
4.von Hayek (1989), pp. 3–7.
5.Interest rates are for constant maturities. Source: Board of Governors of the Federal Reserve System.
6.It is unlikely that all of the money growth would occur in a single year. Annual inflation rates, then, would depend on the number of years it takes for the money expansion to occur. Those rates are also affected by production growth and changes in money demand.
7.In the spirit of the Enlightenment, Fisher maintained that “our unstable and unstandardized monetary units are among the last remnants of barbarism and are out of place in present-day civilization.” See Fisher (1919), pp. 156–157.
8.See Atkeson and Kehoe (2004), pp. 99–103. Using data for 17 countries and covering more than 100 years, they find virtually no link between deflation and depression.